Workers may be more willing to save for retirement if they can have access to their savings for emergencies before retirement. 1). In addition, a recent study found that the type and quality of information provided to employees on 401(k) plans may also be an important factor in encouraging employee participation in 401(k) pension plans. Employer matching also increases average contribution amounts in 401(k) plans but not to the same extent as loan provisions. 2). 3). Plan borrowers, on average, have less family income, lower net worth, and more nonhousing debt than nonborrowers. But participants who have recently been turned down for a loan from another source are almost 40-percent more likely to borrow against their pension account than other plan participants, holding all else equal. A smaller proportion of pension-plan borrowers report having housing debt than nonborrowers, but a larger proportion report having education loans (see table 2). Borrowing From Pension Account May Reduce Retirement Income

Pension-plan participants who borrow from their pension accounts risk having substantially lower pension balances at retirement. Pension-plan loans, however, generally have a favorable interest rate, which may be much lower than the return on the pension-account investments. However, pension-plan borrowing is a two-edged sword: Individuals who were prompted to participate because of the borrowing provision increase their retirement savings, but individuals who opt to borrow lose some of the tax advantages to retirement savings and risk having less income at retirement. Consequently, individual Social Security accounts would not benefit from the positive aspects of borrowing provisions, but the borrowing provisions would increase the risk of reduced retirement income. Scope and Methodology

To determine how pension-plan borrowing affects workers’ participation in and contributions to a pension plan and retirement income, we addressed the following questions:
Does the ability to borrow from defined contribution pension accounts increase participation in and contributions to 401(k) pension plans? What are the potential consequences for participants who borrow from their retirement accounts? We used the Survey of Consumer Finances to determine the effects of pension-plan borrowing on participation in and contributions to 401(k) pension plans and to describe the demographic and economic characteristics of workers who borrow from their pension accounts. For example, the coefficient estimate of 0.0591 for the borrowing variable indicates that plans that allow participant borrowing have participation rates that are about 6 percentage points higher than plans that do not allow borrowing. The results show that as long as the interest rate of the loan is less than the rate of return of the pension account balance (assumed to be 11 percent), borrowers will have a lower account balance at retirement.
Why GAO Did This Study

Pursuant to a congressional request, GAO: (1) determined the effects of pension-plan borrowing on participation in and contributions to 401(k) pension plans; (2) described the demographic and economic characteristics of workers who borrow from their pension accounts; and (3) identified the potential consequences for participants who borrow from their pension accounts.

What GAO Found

GAO found that: (1) plans that allow borrowing have a somewhat higher proportion of employees participating than other plans, all other factors being equal; (2) in addition to employer matching, allowing borrowing increases participation among eligible employees, especially lower-income employees; (3) allowing pension-plan borrowing also significantly affects how much employees contribute; (4) participants in plans that allow borrowing contribute, on average, 35 percent more to their pension accounts than participants in plans that do not allow borrowing; (5) based on individual financial data GAO examined, relatively few plan participants--less than 8 percent--have one or more loans from their pension accounts; (6) this is true for a point in time and would not include those who had repaid a past loan or who might borrow in the future; (7) blacks and hispanics, lower-income individuals, participants who have recently been turned down for a loan, and workers who also are covered by other pension plans are more likely to borrow from their pension account than other participants; (8) plan borrowers, on average, have fewer assets than nonborrowers and have more nonhousing debt relative to income than nonborrowers; (9) while borrowing provisions may reduce retirement income, they also can encourage workers to save for their retirement; (10) loan provisions of many pension plans provide for repaying the loan at favorable interest rates, which may be lower than the investment yield that could have been earned had the money been left in the pension account; (11) consequently, the borrower will have a smaller pension balance at retirement, since the interest paid to the account is less than what the account balance could have earned form investing in equities; however, other potential effects of borrowing could outweigh these disadvantages; (12) if loan provisions influenced the employee's decision to participate in the pension plan, the employee's retirement income would likely have been even less had there not been such provisions; (13) allowing participants to borrow from their defined-contribution pension plan, therefore, may be a double-edged sword; and (13) there are both advantages and disadvantages to borrowing from other voluntary retirement savings accounts, such as individual retirement accounts, however, few of the positive effects of pension-plan borrowing would be realized in mandatory retirement programs like Social Security.