‘Show Me’ the Money with Retirement Savings Leakage

“Your frothy eloquence neither convinces nor satisfies me. I am from Missouri. You have got to show me.” – Former Missouri Congressman Willard Duncan Vandiver

Though I’m not from Missouri, I sometimes like to paraphrase another famous Show-Me State politician, Harry Truman: A person either is constantly on top of events or, if they hesitate, events will soon be on top of them.

I am one of a handful in the “retirement industry” who embraces “Full Auto”.[i]  And, few agree with me that retirement preparation can be improved by prospectively eliminating in-service and hardship withdrawals, while concurrently increasing liquidity via plan loans, “done right”—what I call “liquidity without leakage along the way to and throughout retirement”[ii].

So, today, I read with great interest two articles that say participants could avoid $2 trillion in retirement savings “leakage” if every borrower was automatically enrolled in insurance against plan loan defaults.[iii]

I don’t know

Since this study and these articles do not match my experiences over 40+ years in employee benefits, including 25+ years at insurance and financial services firms, I guess I don’t know what I don’t know.

I also like to parody rock ‘n roll oldies hits. With apologies to Sam Cooke and his hit, Wonderful World[iv]:

Don’t know much about indemnity,

Don’t know much about security,

Don’t know much about insurance books,

Moral hazard mostly gobbledygook,

If payouts exceed premiums, say what?

Then if’s and buts are candy ‘n nuts,

What a wonderful world this would be.

To avoid leakage, plan loan default insurance is something every participant should consider, just as they would prepare for any other loan – looking at backstops, such as a line of credit, a home equity loan, etc. When a participant elects a plan loan, it is usually because the plan loan is superior to borrowing from commercial sources. Other times they select the plan loan because they are not creditworthy, or credit options are suboptimal (payday loans, title loans, credit card cash advances, etc.) So, regardless of the source of credit, a borrower should prepare for contingencies.

Apparently, this study did not consider how participants with commercial loans respond to an interruption of wages at separation. Participants often cash out to cover their debts.

Automatic loan default insurance—Help me understand

The study purports to identify the impact on leakage where loans automatically come with insurance against defaults. So, help me out. Feel free to respond to my questions. Refer me to analysis and studies that address my confusion and concerns. Email me at jacktowarnicky@gmail.com.

• The agencies have often asserted that fees = leakage. Insurance has its place. We need it for the unexpected and for challenges an individual cannot easily prepare for on their own. We also know that over time, there is a price to pay for the security insurance provides – insurance premiums must always, over time, exceed the actual benefits paid. So, participants with loans, as a group, will have less retirement savings, not more, because, over time, insurance premiums must always exceed insurance proceeds, right?
• 90% of loans are successfully repaid[v]. Of the 10% that default, almost all occur at separation because most service providers have not updated plan loan processing to 21^st Century functionality, nor have plans adopted loan default “rollover” processes.[vi] The 90% who were automatically covered and do not default will see a reduction in their account balances, right? And, since 70+% of separations may be voluntary[vii], many who default will not qualify for insurance proceeds, right?
• Seems like a candidate for moral hazard. If I know or suspect I am going to be let go, why wouldn’t I run out and take the maximum loan possible, if only to tide me over until my next gig, right?
• Most who borrow but do not default are active employees. Most who borrow and default have separated. There is a validated human resources strategy in there somewhere, right?
• I am not sure why other benefits paid at separation are insufficient. If not, wouldn’t every plan sponsor want to pay the insurance premium and remove the burden from participants who do not default – to add one more benefit for those who separate, right?
  • Death – Life insurance, as workers likely had other debts too
  • Disability – LTD benefits, perhaps augmented with other insurance that would continue retirement savings contributions[viii]
  • Involuntary separation—Offer severance pay when appropriate, fund unemployment benefits
  • Voluntary separations—Participants should always be prepared to repay the loan at separation, using liquidity from another source. 

Show me. Oh, what a wonderful world this would be.

Disclaimer No. 1: My comments are my own based on my past experiences in plan sponsor and consulting roles, and do not necessarily reflect those of any employer, group or association I have been employed by or affiliated with, past, present, or future.

Disclaimer No. 2: This information was provided by individuals with knowledge and experience in the industry and not as legal or tax advice. The issues presented here may have legal implications and you should discuss this matter with legal counsel prior to choosing a course of action. This article is intended to be informational only. It is not (and you/others should not use it as a substitute for) legal, accounting, actuarial, or other professional advice. Any advice contained in this article was not intended or written to be used, and cannot be used by anyone for the purpose of avoiding any Internal Revenue Code penalties that may be imposed on such person [or to promote, market or recommend any transaction or subject addressed herein]. You (others) should seek advice based on your (their) particular circumstances from an independent tax advisor.

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[i] J. Towarnicky, Is It Time for Full Auto? Benefits Quarterly, 1^st Qtr 2020

[ii] J. Towarnicky, My Financial Wellness Solution, the 401(k) as a Lifetime Financial Instrument, Society of Actuaries, 2017, https://www.soa.org/globalassets/assets/files/resources/essays-monographs/financial-wellness/2017-financial-wellness-essay-towarnicky.pdf See also: J. Towarnicky, Adding a Sidecar Savings Account for Emergency Savings? Better Solutions May Exist, Benefits Quarterly, 1^st Qtr 2022, See also: J. Towarnicky, Practical Dreaming, What Are Your 401(k) Participants Dreaming About? Benefits Quarterly, 4^th Qtr 2021, See also: J. Towarnicky, Debt or Deferrals … College or Contributions? A 401k Can Do Double Duty, Benefits Quarterly, 3^rd Qtr 2019, See also: J. Towarnicky, Qualified Plan Loans: Evil or Essential? Benefits Quarterly, 2^nd Qtr 2017

[iii] B. Anderson, Auto-Enrolled 401k Loan Protection Has Potential to Save $2 Trillion, 401kSpecialist.com, 4/7/22, https://401kspecialistmag.com/auto-enrolled-401k-loan-protection-has-potential-to-save-2-trillion/ See also: D.  Shaw, The Potential Impact of 401(k) Loan Default Protection, 4/6/22, https://www.planadviser.com/potential-impact-401k-loan-default-protection/

[iv] Sam Cooke, What a Wonderful World, https://www.youtube.com/watch?v=R4GLAKEjU4w 

[v] O. Mitchell, S. Utkus, T. Lu, J. Young, Borrowing from the Future: 401(K) Plan Loans and Loan Defaults, 4/20/15,  https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2596431 See also: R. Toth, The Wharton Loan Default Study: Documenting Unemployment’s Unrecognized Penalties, Business of Benefits, 2/24/14, https://www.businessofbenefits.com/2014/02/articles/general-comment/the-wharton-loan-study-and-the-loan-default-documenting-unemployments-unrecognized-penalties/

[vi] J. Towarnicky, Top 10 401k Plan Loan Myths, Misdirections and Misrepresentations, 2/17/21  https://401kspecialistmag.com/top-10-401k-plan-loan-myths-misdirections-and-misrepresentations/  J. Towarnicky, Stop Leaks, Plan Loans, 11/29/20 https://401kspecialistmag.com/how-to-stop-401k-leakage-from-plan-loans/

[vii] Bureau of Labor Statistics, Job Openings and Labor Turnover, February 2022, 3/29/22, https://www.bls.gov/news.release/pdf/jolts.pdf

[viii] IRS, Tax Treatment of Qualified Retirement Plan Payment of Accident or Health Insurance Premiums; Correction 5/12/14, https://www.federalregister.gov/documents/2014/07/07/2014-14989/tax-treatment-of-qualified-retirement-plan-payment-of-accident-or-health-insurance-premiums