Congress: Did You Ever Have to Make Up Your Mind?

When the SECURE Act passed[i], I got the impression that Congress had finally spoken and decided that the tax preferences for retirement savings plans were intended for, well, retirement. Section 108 prohibits qualified plans from making loans through credit cards and similar arrangements.

I’m not sure what “similar arrangement” means, but it seems clear that buying a bag of potato chips at Krogers via a plan loan using a credit card is verboten.

But, reading further in SECURE, I soon became (re)confused (is re-confused a word?). Section 113, just five sections later, provides for penalty-free withdrawals of up to $5,000 per participant from retirement plans for childbirth or adoption. So, a pair of working parents could withdraw, penalty tax-free, $10,000 per child, if the workers’ plan(s) so permitted.

Three other times, in immediately preceding and subsequent years, Congress authorized plan sponsors to make in-service withdrawals easier and in greater amounts—only once were lawmakers prompted by COVID-19:

The Bipartisan Budget Act of 2018[ii] liberalized the rules for hardship withdrawals.
The CARES Act[iii] (2020) eliminated any hardship requirement for qualified individuals; they could withdraw up to $100,000, avoid penalty taxes, and receive three-year income tax averaging and repayment options. Often, when one spouse qualified, so did the other—up to $200,000!
The Consolidated Appropriations Act[iv] (2021) added withdrawal provisions similar to CARES Act provisions if a participant’s principal residence is within a federal-declared disaster area (for economic losses between December 28, 2019, and February 25, 2021).

And, long before COVID-19, Congress created exceptions allowing savers to waive the 10% penalty taxes on premature withdrawals from IRAs—for higher education, first-time home purchases, unreimbursed medical expenses, and more.

Here we go again?

Now, here cometh the 117^th Congress. First, the House passed the Securing a Strong Retirement Act, H.R. 2954[v], with a vote of 414 – 5. Section 318 provides for penalty-tax-free withdrawals in cases of domestic abuse in an amount not to exceed the lesser of $10,000 or 50% of the account value. Next comes the Senate with a variety of bills, including S.4808, the Enhancing American Retirement Now Act (the “EARN Act”), S. 4353, introduced by Senators Wyden (D, OR) and Crapo (R-ID).

Previously introduced legislation includes: the Retirement Improvement and Savings Enhancement to Supplement Health Improvements for the Nest Egg Act (the “RISE & SHINE Act”) offered by Senators Murray (D-WA) and Burr (R-NC) and S. 1870, the Enhancing Emergency and Retirement Savings Act of 2021 offered by Senators Lankford (R-OK) and Bennet (D-CO).[vi]

In addition to the provision for penalty-tax-free withdrawals in cases of domestic violence, participants would now be able to withdraw $1,000 penalty-tax-free once a year “for purposes of meeting unforeseeable or immediate financial needs relating to necessary personal or family emergency expenses.”

The proposed statute would allow the plan administrator to “rely on an employee’s certification that the employee satisfies the conditions” – in other words, for most practical purposes, a plan that adds this provision will permit distributions of up to $1,000 a year for good reason, bad reason, or no reason whatsoever.[vii]

Stop the drip, drip, drip

Jeez, last year, even Alicia Munnell of the Boston College Center for Retirement Research suggested, perhaps a little tongue in cheek, that Congress should allow retirement plans to add a credit card feature.[viii]

This benefits professional argues in favor of “liquidity without leakage along the way to and throughout retirement.”

To achieve that, we might encourage plans to update plan loan processing to 21st Century functionality and curtail in-service hardship withdrawals (and other in-service withdrawals). Further, Congress should remove the anti-cutback barriers for prospective changes to limit post-separation, pre-retirement distributions.

And Congress should clarify processes and features that plan sponsors could deploy to retain assets – to turn the 401k or other retirement savings plan into a lifetime financial wellness instrument.[ix]

Encourage liquidity without leakage instead

The goal is to have adequate (retirement and non-retirement) savings. To accomplish that result, Congress should discourage withdrawals and distributions before retirement while encouraging the adoption of 21st Century plan loan structures, processes, and features that are tax-efficient and cost-effective (see Sidebar 1).

Unlike withdrawals and distributions, plan loan principal never leaves the plan. Instead, it becomes a fixed income investment, in the participant. Many times, when it comes to the financially fragile, especially those who are not creditworthy, plan loans are superior to loans from commercial sources (credit card cash advance, payday advances, etc.)

For most workers, borrowing from the 401k plan can concurrently improve both household wealth and retirement preparation.

Sidebar 1
21^st Century Plan Loan Processes
To be effective as an all-purpose savings accumulation tool, most plan sponsors/service providers need to update 401k loan processing to 21st Century functionality – changing processing to electronic banking, the loan structure to a line of credit, and adding behavioral economics tools, processes, and concepts. Electronic banking and line of credit structures are widespread in banking today, so they are self-explanatory. In terms of behavioral economics, the plan’s process should consider including features such as requirements that the individual:

Execute the Note Security Disclosure loan application documentation as both the borrower and the lender (future self),
Execute a “commitment bond” to confirm that the loan must be repaid, and to attest that the participant has prepared for any default by securing access to funds from another source, and
Provide banking information and an authorization for deduction triggered by missing a payroll deduction.

How? Specifically, over the past 15 years, the interest rate on a plan loan has usually been less than the interest rate on loans from commercial sources. And, over the past 15 years, the interest rate on a plan loan was almost always more than the rate of return on the plan’s fixed income investments. Where both are true, the plan loan can concurrently improve both household wealth and retirement preparation.

And, if liquidity is the goal, keep in mind that for many, perhaps most workers, many “big ticket” financial needs are sequential – allowing the loan and repayment process to meet iterative needs. So, perhaps the Senators can create the Bank of Ron, Patty, and/or James (see Sidebar 2):

Got a better recommendation? Happy to review, discuss, and debate. Contact me at: jacktowarnicky@gmail.com

Disclaimer No. 1: My comments are my own based on my past experiences in plan sponsor roles and do not necessarily reflect those of any employer or association I have been employed by or affiliated with, past, present, or future.

Sidebar 2
Bank of Ron, Patty and/or James

Save (automatic features)
Get Match
Invest
Accumulate
Borrow to meet current need
Reallocate assets to target asset allocation (treat loan principal as fixed income investment)
Continue contributions while
Repaying the loan to
Rebuild the account to a larger amount for future needs
Repeat as necessary up to and throughout retirement.

Disclaimer No. 2: Information was provided by individuals with knowledge and experience in the industry and not as legal or tax advice. The issues presented here may have legal implications and you should discuss this matter with legal counsel prior to choosing a course of action. This article is intended to be informational only. It is not (and you/others should not use it as a substitute for legal, accounting, actuarial, or other professional advice. Any advice contained in this article was not intended or written to be used and cannot be used by anyone for the purpose of avoiding any Internal Revenue Code penalties that may be imposed on such person [or to promote, market or recommend any transaction or subject addressed herein]. You (others) should seek advice based on your (their) particular circumstances from an independent tax advisor.

[i] Division O – Setting Every Community Up for Retirement Enhancement, Further Consolidated Appropriations Act, 2020, Pub. L. 116–94, Signed by President Trump on 12/20/19

[ii] The Bipartisan Budget Act of 2018, Pub. L. 115-123, Signed by President Trump, 2/9/18

[iii] The Coronavirus Aid, Relief, and Economic Security Act, Pub. L. 116-136, Signed by President Trump, 3/27/20

[iv] The Consolidated Appropriations Act of 2021, Pub. L. 116–260, Signed by President Trump, 12/27/20

[v] H.R. 2954, Securing a Strong Retirement Act,

https://www.congress.gov/bill/117th-congress/house-bill/2954/text

[vi] S. 4808, Enhancing American Retirement Now Act, Accessed 9/19/22 at: https://www.finance.senate.gov/imo/media/doc/EARN%20Act.pdf ; S. 4353, Retirement Improvement and Savings Enhancement to Supplement Healthy Investments for the Nest Egg Act” or the “RISE & SHINE Act”, introduced 6/7/22, Accessed 9/19/22 at: https://www.congress.gov/bill/117th-congress/senate-bill/4353 ; S.1870 – Enhancing Emergency and Retirement Savings Act of 2021, Introduced 5/27/21, Accessed 9/19/22 at: https://www.congress.gov/bill/117th-congress/senate-bill/1870/titles

[vii] Note iv, supra. While the plan administrator may accept the worker’s certification of eligibility for an emergency personal expense distribution, the Secretary may provide:

Regulations for exceptions to the rule allowing for emergency personal expense distributions in cases where the plan administrator has actual knowledge to the contrary of the employee’s certification, and
Procedures for addressing cases of employee misrepresentation.

[viii] A. Munnell, Opinion: Proposed legislation would allow $1,000 penalty-free 401(k) withdrawal. Maybe it’s time to rethink adding a credit card to 401(k) accounts. 7/6/21. “… The rationale (for $1,000 penalty-tax-free withdrawals) is that low-paid workers are more likely to save if they know they have access to their money if they should need it. Indeed, the empirical evidence clearly shows that employees are more likely to participate in and to contribute more to a plan that offers loans. That makes sense. People feel better if they think their money is not totally locked up…. My favorite idea for access, however, is an old plan put forth in the 1990s by the late Franco Modigliani, an MIT economics professor and Nobel laureate, and Francis Vitagliano, an employee benefits practitioner and friend. Under the Modigliani-Vitagliano plan, employees could have convenient access to a limited amount of their 401(k) money through a credit card. … So, I think the product is great. But in addition to the widespread theoretical opposition, it was a commercial failure. The 401(k) credit card was presented to the market in 2012, using a Visa card. … these accounts saw very little activity. After approximately 18 months, the 401(k) card project was terminated.” Accessed 9/19/22 at: https://www.marketwatch.com/story/proposed-legislation-would-allow-1-000-penalty-free-401-k-withdrawal-11625532808 See also: J. Towarnicky, Another Nobel Laureate in Economics Who Was Focused on 401(k) Plans – Part 2 of 3, 12/4/17. “… Franco Modigliani, the 1985 winner of the Alfred Nobel Memorial Prize in Economic Sciences for his pioneering analyses of saving, and specifically his life-cycle hypothesis of household saving. … Since consumption is distributed over a lifetime, (Modigliani) argued that workers naturally build up a stock of wealth while active that would be consumed during old age. Sounds like a 401(k) plan to me. A famous twist … was that almost 25 years ago, Professor Modigliani patented a method for issuing 401(k) credit cards with the aim of increasing liquidity from 401(k) plans (https://www.google.com/patents/US5206803 ). He believed workers should be able to utilize retirement savings without triggering leakage – confirming the dual-purpose nature of 401(k) plans that can be used to meet current consumption needs, and when loans are repaid, can rebuild the account for future needs. Monies would be available up to and throughout retirement. This author believes 21st Century liquidity provisions are essential if your goal is to encourage retirement preparation/savings by those working Americans who live paycheck to paycheck. …”, Accessed 9/19/22 at: https://www.psca.org/news/blog/another-nobel-laureate-economics-who-was-focused-401k-plans-part-2-3

[ix] J. Towarnicky, My Financial Wellness Solution: The 401(k) as a Lifetime Financial Instrument, Society of Actuaries, 2017, Accessed 9/19/22 at: https://www.soa.org/globalassets/assets/files/resources/essays-monographs/financial-wellness/2017-financial-wellness-essay-towarnicky.pdf