1) Loans are popular but……… - if we look to the US experience around 401Ks, loans certainly seem to be popular with around 10% of 401k participants initiating a new loan last year1. Overall, around 21% of participants have a loan outstanding2. Over half of these have more than one loan1, suggesting that the flexibility can lead to a slippery slope to more and more borrowing and facilitate a group who are very heavily reliant on loans.
2) Losing returns on your investment – you could argue that it’s better to borrow from yourself than from a bank and, in theory, this is true. The rate of interest you pay is likely to be lower, you won’t get credit scored and any interest that is paid goes back into your account. However, when you borrow from a 401k plan, what you’re actually doing is redeeming investments in your account and then repurchasing them using the loan repayments. So while you’re earning interest on the amount withdrawn, you’re foregoing investment returns. In the long run this is likely to drag on overall investment growth therefore impacting on the potential future benefits from the plan.
3) Repaying the loan – despite what we may think, default rates are relatively low in the US but this is largely because repayments are made via payroll and deducted automatically. Where defaults do often occur is where an individual leaves employment with a loan. Then they have 90 days to repay the loan which may be difficult especially if they are not leaving by choice. If the loan is not repaid then the outstanding balance is treated as a withdrawal, is taxed and has a 10% penalty applied, putting an even bigger hole in the participant’s retirement plans. The Lifetime ISA would normally not be funded from payroll deductions and, without this automatic system, the risk of default will inevitably be higher.
4) The impact on normal contributions – with default rates low then what is the harm of a loan? The US experience shows that those taking loans from a 401k will often reduce their normal retirement contributions. In fact, 25% of those taking out a loan reduced contributions in the following five years with 15% stopping contributions altogether1. Combined with having assets out of the market, this can have a significant impact on achieving savings goals.
5) Keep it simple – getting ready for the LISA come April 2017 is a major undertaking for providers. Getting this right in its original form has to be the focus. We can then assess whether the LISA provides enough flexibility to encourage people to save or if we need to add more bells and whistles to what should be a reasonably simple product.
Richard Parkin, Head of Pensions at Fidelity International, said:“So what does this mean for the Lifetime ISA? I think we have to be very cautious about implementing a loan facility where there is no existing collection mechanism such as payroll deduction. What would stop individuals from simply contributing then borrowing the money back and repaying through existing contributions? That doesn’t seem like something that should be supported by government subsidy.
“Let’s make sure we get the LISA fit for purpose. We don’t want to rush through any decisions in haste that we may regret at leisure.”
|
