A new report suggests that more than $2 trillion in potential future 401(k) account balances will be lost due to plan loan defaults over the next 10 years unless action is taken by plan sponsors and policymakers.
The analysis by Deloitte finds that the cumulative effect of loan defaults — including taxes, early withdrawal penalties, lost earnings and early cash-outs of defaulting participant’s balances — represents approximately $300,000 in lost retirement over the career of a typical defaulting borrower.
“Without the proper education and advice, appropriate plan design, and implementation of new solutions, the trend of loan leakage from retirement assets may continue alongside an ongoing trend of loan utilization,” the firm cautions in its report, “Loan Leakage: How can we keep loan defaults from draining $2 trillion from America’s 401(k) accounts?”
Opportunity Costs
Overall, the study estimates $7.3 billion in loan defaults in 2018, with subsequent withdrawal of voluntary cash-outs at $48 billion. When factoring in combined lost opportunity costs associated with these leakage amounts, the results show projected leakage at retirement of $210 billion. The study then looks at the impact of loan leakage over a 10-year period and finds nearly $2.5 trillion in projected leakage at retirement.
And while 401(k) loans have been shown to increase plan participation, the analysis cites data from a Wharton/Vanguard Pension Research Council Working Paper finding that nearly 40% of participants have taken advantage of a loan offering to finance current consumption, and that 86% of participants defaulted on their loans after leaving employment. It further cites EBRI data showing that nearly two-thirds of participants’ reduced retirement savings is due to leakage associated with cash-outs from job change.
Product and Policy Solutions
Common solutions to limit future retirement setbacks from retirement loan defaults include policy changes to plan design, loan education programs, debt consolidation, payroll program automation and 401(k) loan insurance, the firm explains. To build on that, the report also recommends:
- pre-tax wellness plans (e.g., HSA, FSA, Section 529) as part of current benefit lineups;
- debt-management programs for participants struggling with student, credit card and household debt;
- 401(k) plan loan insurance that automatically prevents loan defaults and punitive consequences due to involuntary job loss;
- preapproved emergency loan options that allow automatic payroll deductions from a participant’s paycheck;
- rainy-day savings plans holding a fixed rate of return on a small percentage of payroll assets that are automatically deducted each pay period;
- education and loan risk awareness programs designed and curated for fiduciary responsibility, prior to lending approval;
- a reduction in permissible loan amounts and number of loans outstanding per participant, and increase flexibility in payback timelines; and
- enforced waiting periods for plans that are currently designed with multiple loan originations and payoff dates, resulting in overall reduction of loans available.
Deloitte submits that, while eliminating loans altogether is likely not the answer, “finding the right balance of product innovation, technology, plan design, and education considerations could help plug the leak.”
