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Commentary

Another Small Crack in the Retirement System

Congress looks for further ways to turn our retirement system to a general savings system.

Congress is on the verge of adding yet another way to take money penalty-free out of a retirement account. It’s not that this provision is particularly terrible or problematic, but it adds to a fundamental problem with our system: Employers and advisors usually act as though we have a retirement system. We don’t. We have a savings system, because the money can be--and is--used for a variety of other, nonretirement purposes.

Specifically, Congress is expected to eventually pass the provisions of the H.R. 1994 - Setting Every Community Up for Retirement Enhancement Act of 2019, or SECURE. Among a laundry list of items is a provision that would allow people to take up to $5,000 out of an IRA or defined-contribution plan for expenses for the birth or adoption of a child. After taxes, this will probably come to closer to $4,000, although that depends on the participants’ income and marginal tax rate.

On its own, this provision is not going to erode retirement security broadly, and it even includes provisions for repaying the withdrawal. (Of course, new parents or those with growing families are likely to have more expenses and less money to pay this amount back than they did before the adding a new child.)

But, should this new child distribution become law, it would join a long list of ways to direct “retirement” funds to nonretirement purposes. Apart from withdrawals for retirement or disability, there are exceptions for withdrawals from IRAs for college costs, to buy a new home, and for health insurance premiums for unemployed workers. Inside a workplace retirement plan, there are exceptions for hardship as well as loans for buying a home and for any other purpose, although these need to be paid back.

Why is it a problem to have a savings system instead of a retirement system? First, most experts think people are undersaving anyway, and leakage from the system exacerbates the problem. In fact, prime-age workers remove more than $69 billion from the system every year, according to government estimates. Of course, advisors (and employers) usually try to encourage people to keep their retirement savings for their intended purpose, but that’s harder to do when there are so many ways to take money out of the system.

Another important consideration is that plan sponsors and IRA advisors generally direct people to invest for the long term, including increasingly through target-date funds that usually aim to invest for the long haul, with higher levels of exposure to riskier assets for younger participants. These asset allocations do not make much sense if people are taking this money out for near-term expenses.

Also, Congress never removes ways to take out money from the system; it just keeps adding more ways to use retirement money for nonretirement purposes. Each of these exemptions has a constituency, and they encourage other advocates to try to get access to retirement funds for their group’s priorities. So, we keep turning the retirement system more into a general savings system.

There is an argument for allowing some leakage from the retirement system if it encourages people to save more in their 401(k) or IRA. For example, knowing that I can take money out of my 401(k) in case of hardship or borrow from it for a short-term expense might induce me to save a little more for retirement through my workplace plan. I know I am not giving up access to these retirement savings if I really need them before retirement. But, when people want to save for goals other than retirement, they shouldn’t look first to their retirement account as a vehicle, and policymakers keep encouraging them to do just that. On its own, this provision is no big deal, but it’s just another crack in an already fragile system.