Boon or Bane?: 401(K) Loans and Loan Provisions

Forthcoming, Research on Aging

30 Pages Posted: 10 Oct 2011 Last revised: 18 Oct 2013

See all articles by Jeffrey B. Wenger

Jeffrey B. Wenger

RAND Corporation; American University - School of Public Affairs

Christian E. Weller

University of Massachusetts Boston - Department of Public Policy and Public Affairs; University of Massachusetts Boston - Gerontology Institute; Political Economy Research Institute

Date Written: October 9, 2011

Abstract

Traditional life-cycle models unambiguously predict that having the ability to borrow from defined contribution (DC) plans is utility enhancing since lower liquidity constraints will increase contemporaneous contributions. Behavioral finance, on the other hand, indicates that workers with dynamically inconsistent preferences may enjoy higher lifetime consumption than otherwise if they have no loan option. The lack of loan option acts as a commitment device to preserve savings for future consumption. Absent the commitment device contributions may be lower than otherwise. We study DC plan contributions for those with standard and with dynamically inconsistent preferences and find that a loan option raises current savings, but does so more for households with standard discounting than for those with dynamically inconsistent preferences. The effects on lifetime savings may differ, depending on the actual loans taken out and when the loan option exists. We simulate retirement account balances, using our parameter estimates for contributions and loan amounts, for households with standard and dynamically inconsistent preferences. The simulations show that the net effect is positive for standard discounters, but not necessarily for dynamically inconsistent discounters, depending on the impact of the borrowing option on employee contribution rates to DC plans.

Keywords: defined contribution, retirement savings, 401(k) loans

Suggested Citation

Wenger, Jeffrey B. and Weller, Christian E., Boon or Bane?: 401(K) Loans and Loan Provisions (October 9, 2011). Forthcoming, Research on Aging, Available at SSRN: https://ssrn.com/abstract=1941411 or http://dx.doi.org/10.2139/ssrn.1941411

Jeffrey B. Wenger (Contact Author)

RAND Corporation ( email )

1776 Main Street
Santa Monica, CA
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310 393 0411 (Phone)

American University - School of Public Affairs ( email )

Washington, DC 20016
United States

Christian E. Weller

University of Massachusetts Boston - Department of Public Policy and Public Affairs ( email )

McCormack Graduate School
100 Morrissey Boulevard
Boston, MA 02125
United States
2024605821 (Phone)

HOME PAGE: http://blog.umb.edu/christianweller

University of Massachusetts Boston - Gerontology Institute ( email )

100 Morrissey Boulevard
Boston, MA 02125-3393
United States

Political Economy Research Institute ( email )

Amherst, MA
United States

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