Loan features in 401ks are a fantastic idea in theory—in practice, not so much.
Human behavior naturally dictates abuse, at least for some, and default rates are costing participants bigtime.
It’s not just the amount lost in current dollars, but the opportunity cost from a lack of appreciation and compounding in future years.
Deloitte Consulting reports that defaults account for $210 billion in lost savings when those lost savings are compounded over the course of their careers.
The Wall Street Journal’s Anne Tergesen tallies the damage in a piece on Thursday.
“The projected future loss amounts to about 2.7 percent of the $7.8 trillion currently in 401k-style retirement accounts,” she writes. “The numbers highlight the problem of tapping 401k savings before retirement, known in the industry as leakage. Most leakage occurs because about 30 percent to 40 percent of people leaving jobs elect to cash out their accounts and pay taxes or penalties rather than leave the money or transfer it to another 401k or an individual retirement account.”
However, loans are a major source of outflow, and about 90 percent of 401k plans currently offer the provision.
Citing Investment Company Institute data, Tergesen notes that about one-fifth of 401k participants with access to 401k loans take them, and about 10 percent default, “triggering taxes and often penalties.”
“Money lost to 401(k) leakage, including loan defaults and cashouts, reduces the wealth in U.S. retirement accounts by an estimated 25 percent when the lost annual savings are compounded over 30 years,” she concludes, using analysis from Boston College’s Center for Retirement Research.
“As a result, Deloitte projects that those who default on loans worth $7.3 billion this year will drain about $48 billion from their retirement accounts. If the $48 billion were to remain in their accounts, it would be worth $210 billion by retirement age, assuming a 6 percent annual return, Deloitte calculated.”