Antiquated 401(k) Rules Bar You From Your Own Money

Commentary

Let’s start by affirming the common-sense principle that a retirement account balance belongs to the saver, not to the government. When an employee earns salary or wages, the U.S. government taxes the income in multiple ways. Payroll and income tax is lost forever, but in concept Social Security and Medicare are a form of forced savings that the individual hopes to recoup in the future. Voluntary retirement savings plans like IRAs and 401(k) plans get favorable tax treatment, so long as the saver doesn’t touch the balance before a certain age.

Funds in a 401(k) represent deferred wages, invested by choice. Yet Congress and the laws it created treat retirement savings as a locked vault. Withdraw before age 59½ and you pay income tax plus a 10 percent penalty. Hardship withdrawals exist, but only after you show an “immediate and heavy financial need,” and yet you still pay a penalty. The message is clear. You may touch your money only when you are in dire straits, and even in your suffering you must pay a toll to Uncle Sam for the privilege of saving your own skin.

Borrowing your own money (by taking out a loan against the 401(k) balance) is a sensible legal alternative that allows the saver to access tomorrow’s asset to meet today’s liquidity need. Borrowing is not a withdrawal, as it must be paid back on a schedule. There is no tax liability and no penalty. The saver borrows from his future self, repays his future self with interest, and the account is thus made more than whole. For a household facing an unplanned medical bill, a down payment, a business opportunity, or a gap between jobs, it is the cheapest and often fastest credit available. No bank need underwrite a loan, and no credit card company compound interest on it at 24 percent.

However, the amount Congress allows Americans to borrow from their own retirement accounts is capped at the lesser of $50,000 or half the vested balance, a limit set during President Ronald Reagan’s second year in office. It was $50,000 in 1982, and it is $50,000 today. Nothing else in the economy has stood still for 44 years, but the loan cap has.

In 1982, $50,000 was real money. It covered about 72 percent of the median price of a new home. Today it covers about 12 percent, not enough for a typical down payment of 20 percent. Since 1982, inflation has stripped away about 70 percent of the value of the U.S. dollar. Adjusted for consumer prices, i.e., to hold the same value in purchasing power, the cap would need to be $171,000 today.

Meanwhile, the assets behind the loan exploded. The S&P 500 has risen about 55-fold since the end of 1982, before dividends. Balances that were modest then are substantial now. The collateral grew, but the credit line was frozen in time.

American households now carry substantially more costs, and in more categories, than they did in 1982. The tool built to cover these needs and other financial surprises has shrunk in purchasing power by nearly three-quarters.

Congress knows the cap is arbitrary and that it can move it. In the COVID-19 panic, the CARES Act of 2020 doubled the borrowing cap to $100,000, and to 100 percent of the vested balance, for pandemic-affected savers who borrowed during a 180-day window. Retirement savings were not decimated; liquidity and savings actually grew as a result of other government initiatives and the temporary inability to spend. Still, the increase lapsed, and the old limit was reinstated. The SECURE 2.0 Act of 2022 later made a $100,000 limit permanent, but only for victims of federally declared disasters. Washington’s position, in other words, is that you may borrow a reasonable sum from your own account if a hurricane flattens your house; otherwise, best wishes and good luck.

Why hasn’t Congress acted? There are at least three reasons.

First, orthodoxy. The retirement policy establishment regards any pre-retirement access as “leakage.” In that view, liquidity is a bug, not a feature. Savers are presumed incapable of managing their own balance sheets and must be protected from themselves. The result is a government paternalism that would have been unthinkable to previous generations of Americans.

Second, retirement savers have no constituency. Contribution limits are indexed and rise nearly every year, and an industry paid as a percent of assets under management has every reason to maintain the status quo. Loans move money out. No lobby fights to raise the bar. Plan sponsors see loans as an administrative nuisance. The saver, the party with the most legitimate vested stake, has no voice at the table.

Third, inertia comes dressed as prudence. Loans can indeed default, most often when a worker loses a job and the balance comes due. That risk is real, but the borrower is the lender, and no one is defrauded or takes a loss except perhaps the saver’s future self. Congress softened the rules somewhat in 2017, giving employment-terminated workers until their tax-filing deadline to roll over an outstanding loan balance. The risk of occasional default is not a good reason to let the cap diminish in purchasing power.

Neglect is a policy choice. The cap is arbitrary and increasingly meaningless.

The fix is simple. Raise the cap to $100,000, the level Congress already tested in 2020 and already grants to disaster victims. (Or better yet, $170,000, to fairly equalize the purchasing power of $50,000 in 1982.) Thereafter, index the cap to inflation, as contribution limits are. Keep the 50 percent of vested balance rule, so one cannot strip an account bare. Keep the mandatory repayment schedule, so loans stay loans and are not used as a disguised early withdrawal.

The cost to the Treasury should be minimal. A loan is not a taxable event, and a default becomes one. The benefit to households is substantial. Emergencies happen and liquidity needs arise. Savers have an asset that they should be able to access in these situations.

Americans were told to save for retirement, and they did. Employer plans now hold about $15 trillion. Much of this balance belongs to middle-class families whose largest liquid asset is that account. Denying them reasonable access to their own capital, except through a penalty or a disaster declaration, pushes them toward credit cards, payday lenders, and home-equity lines at much higher rates.

Retirement money belongs to the hard-working Americans who contributed it. Congress should do its job and serve the public, not the asset management industry. The cap is over 44 years old. It should be retired.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.