Over the next decade, defaults from 401(k) loans could account for $2 trillion lost in potential future account balances, according to a report from Deloitte.
The average defaulting plan participant stands to lose approximately $300,000 in potential retirement account balance, according to “Loan Leakage: How can we keep loan defaults from draining $2 trillion from America’s 401(k) accounts?”
In reality, there has already been more than $2 trillion in “loan leakage,” or lost potential retirement assets, due to 401(k) loan defaults. In the 10 years ending Dec. 31, 2018, retirement plans lost approximately $2.5 trillion in potential assets at retirement due to $86 billion worth of defaults.
According to Deloitte, 90 percent of 401(k) plans offer loans, and nearly 40 percent of 401(k) plan participants have taken advantage of a loan to finance their current consumption. Approximately 10 percent of 401(k) loans default each year on average.
In 2018 alone, $7.3 billion worth of 401(k) loan defaults occurred and $48 billion worth of voluntary plan cash-outs, creating $155 billion in opportunity costs and an estimated $210 billion account leakage at retirement.
Retirement account loan defaults could imperil the retirements of millions of Americans and deal a severe blow to the retirement plan industry, potentially putting plan fiduciaries at risk, said Deloitte, noting that offering 401(k) plan loans is a voluntary, not a fiduciary function.
Yet Department of Labor regulations do govern 401(k) loan programs, requiring that they should not diminish a borrower’s retirement income or cause loss to the plan, and treat the loans as if they were investments “requiring the same fiduciary oversight as any other plan option.”
However, loan administration is typically passed on to 401(k) sponsors with little oversight, wrote Deloitte.
Compounding the issue, plan participants are more likely take loans during an economic downturn, increasing the magnitude of their losses.
Technology may help stem the tide of 401(k) loan defaults, said Deloitte, by creating better dialogue between plan sponsors and employees, providing plan participants with more information about the potential opportunity cost of taking a 401(k) loan and automating loan repayment.