First of all, we need to restate a common-sense principle: retirement account balances belong to the account holders themselves, not the government. When employees earn income, the U.S. government taxes their income in various ways.
Once payroll taxes and income taxes are paid, they cannot be refunded. However, fundamentally, Social Security and Medicare are a form of mandatory savings, where individuals hope to recoup these funds in the future. Voluntary retirement savings plans like Individual Retirement Accounts (IRAs) and 401(k) plans can provide tax benefits as long as account holders do not access the account balances before a certain age.
The funds in a 401(k) account represent deferred wages, chosen for investment by the individual themselves. However, Congress and the laws it sets view retirement savings as a locked vault. If funds are withdrawn before age 59 and a half, individuals not only have to pay income tax but also a 10% penalty. While there are provisions for hardship withdrawals, individuals must prove they have an immediate and heavy financial need, and even then, they still need to pay a penalty. The message is clear: only in dire circumstances can individuals access their own money, and even then, they must pay a toll to the U.S. government to access these life-saving funds.
Borrowing against one’s own money (such as using a 401(k) account balance as collateral for a loan) is a reasonable and legal choice, allowing account holders to use future assets to meet current liquidity needs. Borrowing is not the same as withdrawing, as it must be repaid according to a plan. Borrowing does not incur taxes or penalties. Account holders essentially borrow from their future selves and repay them on schedule, ultimately growing their account balances rather than diminishing them. For families facing unexpected medical expenses, a down payment on a home, business opportunities, or periods of unemployment, this is often the cheapest and quickest way to access credit, without the need for bank approval or paying credit card companies high interest rates up to 24%.
However, Congress allows Americans to borrow from their retirement accounts up to $50,000 or half of the vested balance, whichever is lower. This limit was set in 1982 during the second year of the presidency of Ronald Reagan. The amount was $50,000 then, and remains so today. In the past 44 years, while everything else in the economic landscape has changed, this loan limit has remained unchanged.
In 1982, $50,000 was a significant amount, covering approximately 72% of the median price of a new home at that time. Today, it can only cover about 12%, insufficient for a typical 20% down payment. Inflation has devalued the dollar by about 70% since 1982. Adjusted for consumer price inflation, the current limit should be $171,000 to maintain the same purchasing power.
Meanwhile, the value of assets corresponding to the loans has soared significantly. The S&P 500 index has increased approximately 55 times since the end of 1982 (excluding dividends). What were relatively small assets back then are now quite substantial. The collateral has appreciated, but the loan limits remain frozen.
Today, American households’ expenses have significantly increased compared to 1982, covering a wider range of categories. The tools used to meet these needs and unexpected financial situations have seen their purchasing power shrink by nearly three-quarters.
Congress knows that the loan limit is arbitrarily set and can be changed at will. During the global COVID-19 pandemic panic a few years ago, the CARES Act in 2020 doubled the loan limit to $100,000 and allowed affected account holders to borrow within 180 days up to 100% of the vested balance. Retirement savings did not significantly diminish; in fact, savings actually increased due to other government measures and temporary inability to consume.
However, this increased limit eventually expired, reverting to the original limit. The SECURE 2.0 Act in 2022 later made the $100,000 limit permanent, but only for victims of disasters declared by the federal government. In other words, Washington’s stance is: if a hurricane destroys your home, you can borrow a reasonable amount from your account; otherwise, good luck to you.
Why has Congress not taken action? There are at least three reasons.
Firstly, it is a conservative mindset. Retirement policy makers consider any pre-retirement withdrawals as “leakage.” They view liquidity as a flaw rather than an advantage. Account holders are thought to be incapable of managing their own balance sheets and must be protected from potentially causing self-inflicted losses. The result is a government-style parenting approach, which would have been unimaginable to earlier generations of Americans.
Secondly, retirement savers lack a representative group. Contribution limits are adjusted annually based on the cost-of-living index; however, the pension management industry, which charges fees based on assets under management, has every reason to maintain the status quo. Loans lead to capital outflows. No lobbying group is dedicated to raising the threshold. Retirement plan sponsors see loans as administrative headaches. Savers, as the most legitimate stakeholders, have no say at the decision-making table.
Thirdly, inertia can sometimes masquerade as prudence. Loans can indeed default, with the most common scenario being borrowers becoming unemployed and unable to repay the loan balance when due. This risk exists, but borrowers are also lenders, and beyond the future interests of savers, no one is defrauded or suffers losses. Congress slightly relaxed related regulations in 2017, allowing unemployed individuals to extend the repayment of loan balances past the tax filing deadline. Occasional default risks are not a valid reason to reduce the purchasing power of loan limits.
Ignoring the issue is a policy choice. The limit is arbitrarily set and increasingly unreasonable.
The solution is actually quite simple. Raise the limit to $100,000, a level tested by Congress in 2020 and used for disbursements to disaster victims. (Or better yet, $170,000 to fairly balance the purchasing power of the $50,000 limit from 1982.) Link the limit to inflation, like contribution limits. Maintain the 50% rule for vested balances to prevent accounts from being emptied. Retain mandatory repayment plans to ensure loans remain loans and not used as disguised premature withdrawals.
The cost to the Treasury should be minimal. Loans themselves are not taxable events, while defaults are. Families benefit significantly from this. Emergencies happen, and liquidity needs arise. Account holders have an asset, which they should be able to access in these circumstances.
Americans are told to save for retirement, and indeed, they do. Currently, about $15 trillion is held in retirement accounts provided by employers. Most of these funds belong to middle-class families, and these accounts are their largest liquid assets. If they are not allowed reasonable access to their funds beyond penalties or disaster declarations, they will be forced to use credit cards, payday lenders, and home equity lines at higher rates.
Retirement funds belong to hardworking Americans, those who paid into them. Congress should fulfill its duty to serve the public, not serve the asset management industry. The pension limit has been in place for over 44 years, and it is no longer suitable for the current situation. It is time to consider abolishing it.