The impact of 401(k) loan defaults on retirement savings can be significant, but new research by EBRI shows that automatically enrolling participants in a 401(k)-loan insurance program can help reduce defaults and improve outcomes.
While Department of Labor data, overall, indicates that loan amounts tend to be a negligible portion of total plan assets, previous research by EBRI has shown that defaulting on retirement plan loans can produce significant reductions in retirement balances. In its latest issue brief—The Impact of Adding an Automatically Enrolled Loan Protection Program to 401(k) Plans—EBRI simulates the potential impact of adding an automatically enrolled loan protection program to 401(k) plans.
According to the analysis, such an approach can measurably improve retirement outcomes for those individuals simulated to have at least one loan default. EBRI found that preventing leakage from the system through the use of loan insurance over a 40-year period results in an increase in the present value of 401(k) and rollover IRA balances of $1.96 trillion.
This can go a long way to helping reduce the present value of retirement deficits for U.S. households, as EBRI’s Retirement Security Projection Model (RSPM) shows that the aggregate retirement deficit for all U.S. households ages 35–64 as of Jan. 1, 2020, was $3.68 trillion, the brief notes.
And while the cost of the program will decrease the account balances for those with a loan, EBRI notes that the combined 401(k) and IRA rollover account balances at age 65 for 401(k) participants simulated to have a loan default in the baseline scenario will be increased through retention of:
- the account balance that would otherwise be defaulted; and
- the remaining amount of the account balance for the participants who were simulated to have defaulted on their loan.
According to EBRI’s projections, the average present-value increase in plan balance derived from a loan protection program as a function of the current age of the 401(k) participant is shown as follows:
- Ages 25–34: $150,623
- Ages 35–44: $184,681
- Ages 45–54: $194,529
- Ages 55–64: $195,692
Since the average account balances increase monotonically with age, this would lead one to expect that the present value would be higher for the older cohort, the brief notes. “Offsetting this to some extent is the fact that those in the younger cohorts would have a higher probability of multiple loan default events than those currently in the older cohorts, since they have more years of exposure to a potential loan default,” the brief further emphasizes.
Plan Loan Landscape
As to the overall scope of plan loans, the EBRI/ICI 401(k) database shows that 88% of participants were in plans offering loans; however, only 19% of those eligible for loans had 401(k) plan loans outstanding. As one might expect, loan activity varies with age, tenure and account balance. Of those participants in plans offering loans, the highest percentages of participants with outstanding loan balances were among participants in their 30s, 40s and 50s.
Factoring in all 401(k) participants with and without loan access in the database, 17% had loans outstanding at year-end 2018. Among participants with outstanding 401(k) loans at the end of 2018, the average unpaid balance was $8,162, compared with $7,935 in the year-end 2017 database. The median loan balance outstanding was $4,486 at year-end 2018, compared with $4,293 in the year-end 2017 database.
EBRI further observes that, on average over the past 23 years, among participants with loans outstanding, about 13% of the remaining account balance remained unpaid. What’s more, research from Deloitte—based on anecdotal data from recordkeepers—estimates that 66% of participants who defaulted on their loan took their entire account balance.
