Digging can lead to a “ruff” retirement

I have three pets named after the TV sitcom Seinfeld.  My cats Kramer and Newman, and my dog Cosmo.


Cosmo is a miniature golden doodle.  By nature this breed is very smart and Cosmo is no exception. Even though he is smart and knows better, Cosmo is a digger.  The other day I left Cosmo in the yard and when I returned what did I find?  A LARGE HOLE!

Even if I would not have seen the hole immediately I would have known something was up just by Cosmo’s look of guilt.  If I could read his mind I think he would have said, “I just can’t help it, digging is fun.”  You are probably thinking I am off my rocker…dogs can’t talk and what does this have to do with retirement plans?

When it comes to finances, many plan participants exhibit some of the same characteristics depicted above, they are smart but they are diggers.  Instead of actually digging a hole in the dirt they are digging a hole in their retirement nest egg.  While they know their nest egg is supposed to be used in retirement, one can be lured by the temptation of easy access to money. They do not take the extra step to determine if it is a desire vs. a need or if there’s another avenue to obtain the funds.

Many defined contribution plans allow participants to electronically apply for loans and in-service distributions.  Before the participant even has time to think about the impact, they make a few clicks, and the distribution is approved and they start digging. The fun of a desired purchase is short lived and may leave them with a sense of remorse.  It’s no secret the use of either of these provisions can wreak havoc to a participant’s retirement income because:

  • If money is taken prior to retirement there is likely a permanent loss to savings.  Once withdrawn from the plan, the amounts generally cannot be contributed back into the plan. Therefore, dependent upon the size of the withdrawal and the age taken, it can take a large piece of a participant’s nest egg.
  • Participant loans are allowed in the majority of plans.  The effects of loans include:    -Salary deferral savings may decrease or be suspended during the loan repayment period.                                                                                                                                -Loans generally have a low interest rate and therefore lose out on the opportunity to take advantage of the market returns.                                                                        -Loans may not be repaid in full, leading to permanent leakage of their retirement account. The default of a loan is very common when a participant terminates employment (rarely does it occur while still employed).

To curb participant behavior some have argued that these plan provisions should be removed or be more restrictive (e.g., only allow one loan outstanding at any one time and/or limiting the types of in-service withdrawals allowed) to help drive more successful outcomes. Others have argued if the plan does not offer these provisions then the overall savings and or participation rates will suffer because participants will be hesitant to participate.

For plans with these features it is important that participants are well educated on how the utilization of these provisions could hurt their overall retirement income.  At the end of the day we do not want participants digging a hole they can never get out of.  So the question plan sponsors should ask themselves is whether or not these provisions should be allowed of if there should be restrictions?

Which camp do you fall in?

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