The Potential Impact of 401(k) Default Protection
Overall, data from the U.S. Department of Labor indicates that 401(k) plan loan amounts tend to represent only a small portion of a given investor’s total plan assets, but recent analysis by the Employee Benefits Research Institute shows that defaults on pension plan loans collectively produce significant reductions. in retirement balances.
Specifically, data from EBRI suggests that 401(k)s could collectively preserve a whopping $1.9 trillion in participants’ retirement savings by enrolling participants who take out loans from their 401(k) to the 401(k) loan protection, which protects employees against default. According to the analysis, a typical default on a 401(k) loan will cost, over a lifetime, more than $150,000 for average borrowers aged 25 to 34, more than $184,000 for borrowers aged 35 to 44, more than $194,000 for borrowers aged 45 to 54 and more than $195,000 for borrowers aged 55 to 64.
In its report, the EBRI uses its retirement security projection model to simulate the retirement income adequacy of all US households between the ages of 35 and 64. The RSPM reflects the actual behavior of 27 million 401(k) participants, as well as 20 million people with Individual Retirement Accounts.
The RPSM was used to simulate the increase in present value of 401(k) account balances, both with and without an automatically enrolled loan protection program. The report runs a base case scenario assuming there was no self-enrolled loan protection program in effect and reported each year, if any, that a 401(k) participant was assumed to be in default of payment. Then another simulation was run, assuming the protection program was in place. Simply put, such a protection program can be set up so that a participant’s loan is automatically repaid in the event of death or disability. In the event of involuntary job loss, the insurer can help repay the loan while the member looks for another job.
“The loans allow 401(k) participants to access their retirement savings in an emergency. Unfortunately, when employees leave their jobs, they default and incur taxes, penalties and often cash out their entire account,” says Tod Ruble, CEO of Custodia Financial, whose company sponsored the EBRI research and is a provider. 401(k) loan insurance. “Loan losses don’t have to happen, and this research clearly shows the need for employers to protect their employees with self-enrolled 401(k) loan protection. Loan protection will reduce the US retirement savings gap by billions of dollars.
Also noted in previous research, another way to improve retirement income adequacy could be through the use of automobile portability. As with loan defaults, there is a serious leakage problem when workers without loans change employers, especially when they have only small accounts. In such cases, investors have to start all over when it comes to saving for retirement. Using technology to save time and resources, automatic portability solutions seek to limit leakage by seamlessly transferring retirement accounts from the old employer to the new employer.