(Bloomberg News) Workers will be limited in tapping their 401(k) retirement plans for loans under legislation two senators plan to introduce today that's designed to counter the erosion of retirement assets.

"During these difficult economic times, we are increasingly seeing 401(k) funds being treated as rainy-day funds," Senator Herb Kohl, a Wisconsin Democrat, said in a statement obtained by Bloomberg News. "A 401(k) savings account should not be used as a piggy bank for revolving loans."

Kohl, 76, who's chairman of the Senate Special Committee on Aging, plans to introduce the "SEAL 401(k) Savings Act" with Senator Mike Enzi, 67, a Wyoming Republican. The bill would reduce the number of loans workers may take from a 401(k) and give participants more time to repay after losing a job. It will allow savers to contribute to their plan after taking a hardship withdrawal and ban debit cards linked to the accounts, according to Joe Bonfiglio, a spokesman for Kohl's aging committee.

The Senate bill would limit the number of outstanding loans for each participant to three, Bonfiglio said. Employers would have the option to reduce the number for their plans.

Almost 28 percent of participants in 401(k)-type accounts had an outstanding loan at the end of 2010, which is a record, according to a study released today by benefits consultant Aon Hewitt, a unit of Chicago-based Aon Corp. The average outstanding loan balance was $7,860, said Aon Hewitt, which used a database of about 2 million employees in 110 plans.

Leaving A Job

"The big risk with loans is that participants leave their job," said Alison Borland, head of retirement strategy for Aon Hewitt. Most 401(k) plans require employees to repay loans in full when leaving a job, usually within 60 days, said Borland, who's based in Nashville, Tennessee. Almost 70 percent default, Borland said, so the unpaid funds get counted as taxable income and may add to the burden of a jobless worker.

Depending on the rules of an employer's 401(k) plan, workers generally may borrow from their retirement account for any reason and pay the loan back with interest. About 89 percent of participants were in plans offering loans in 2009, according to the Washington-based Employee Benefit Research Institute, which has a database of 21 million 401(k) savers.

Workers generally may borrow as much as 50 percent of their vested account balance up to a maximum of $50,000, according to the Internal Revenue Service. The loan must be repaid within five years, unless the money was used to buy a primary home.

Payroll Deductions

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