Most of us learn about LDL when we visit our doctors each year. In a physician’s office, LDL stands for low-density lipoprotein, commonly known as ‘bad cholesterol’, and we get concerned if the number is too high.
If we were a 401k plan, LDL would refer to loan default losses and be just as scary.
Retirement LDL is equal to retirement plan loan defaults, penalties, premature taxes, and the investment gains that would have been earned had a loan been repaid and remained invested until the employee reached retirement age.
According to Harvard Health, medical LDL is “considered the most important measurement for assessing risk and deciding on treatment.” We’re told to keep our own LDL below 100, but medical LDL isn’t something we can measure ourselves. It takes an annual check-up to see where things are.
But what if we didn’t know our LDL number because no one was measuring it? We would be walking around seemingly oblivious to the risks we were carrying with us. That brings us back to retirement plans.
A troubling diagnosis
What risks are plans living with?
An influential Deloitte study in 2018 found more than seven billion dollars in loans default across defined contribution plans each year, and the total cost of retirement plan loan defaults could exceed two trillion dollars in the coming decade when all the associated costs, the retirement LDL, are included.
Retirement plans have annual checkups too, but retirement LDL is difficult to measure. So difficult in fact, that most annual plan checkups don’t include it—even though loans are considered a plan investment and ERISA requires plans to review investment performance.
The missing reporting starts at the top. Form 5500, the financial report that retirement plans file each year with the Department of Labor (DOL), only breaks out deemed distributions to active employees—a small subset of total loan defaults—and includes no information about penalties and the projected earnings shortfalls that result.
Loan offsets that occur after workers terminate make up the vast majority of loan defaults, but these are mixed in with other general plan payments.
That doesn’t mean plan sponsors shouldn’t be concerned.
Preston Rutledge, Assistant Secretary of Labor, who might be considered the Surgeon General for retirement plans in this scenario, noted in an April letter that, “ the Department (of Labor) agrees that 401(k) type plans should already be keeping records that differentiate loan offsets from benefit distributions,“ and went on to suggest that DOL would consider modifying Form 5500 further at an appropriate time.
Treatment options
With all these risks plan sponsors might be wondering about treatment options. If a committee is concerned about a fund meeting its performance benchmark, they place the fund on a watch list and eventually replace it if performance does not improve.
Like taking medicine for a common cold. Loans are not that simple. Plan sponsors cannot replace their loan fund with a better one. Instead, plan sponsors need to design a healthier plan or change the way participants use the plan to treat their retirement LDL and avoid these risks.
Some plan sponsors have put limits around loans, seeing the number of loans outstanding as the risk. Other plans are increasing loan fees to discourage borrowing, which risks pushing employees already stressed about money to higher cost sources of funds outside the plan.
A few recordkeepers in the business of managing 401k investor money are promoting sidecar savings accounts for participants. These additional savings accounts can seem like a nice feature, but risk cannibalizing the 401k plan and negatively influencing testing results.
What’s more, they really don’t address 401k borrowing; the typical sidecar account has a few hundred to a few thousand dollars in it, while the average 401k loan is $7,800.
Improving your prognosis
We lower our medical LDL by changing our diet or taking medication. Fortunately, there is a cure for retirement LDL too. Plan sponsors can use loan insurance to protect against loan default.
Employees pay a little more to borrow each month, and the insurance repays the loan of anyone losing a job. Before it defaults.
We rely on physicians to measure our own LDL and identify changes to benefit our health. ERISA puts fiduciaries in charge of retirement plan assets to protect participants from unseen risks.
So, listen to your doctor about your annual medical test results. And ask your fiduciary to begin measuring your retirement LDL.
George L. White is Executive Vice President, Operations at Custodia Financial, a consortium of retirement industry executives working to solve the problem of retirement plan leakage from 401(k) loan defaults.
