Deloitte Suggestions Could Help Plan Sponsor Clients Address Loan Leakage

An analysis from Deloitte finds that more than $2 trillion in potential future account balances will be lost due to loan defaults from 401(k) accounts over the next 10 years.

This figure includes the cumulative effect of loan defaults upon retirement, including taxes, early withdrawal penalties, lost earnings, and any early cashout of defaulting participants’ full plan balances. For a typical defaulting borrower, this represents approximately $300,000 in lost retirement savings over a career.

According to Deloitte, as fiduciaries, plan sponsors cannot ignore the growing risk and potential liability represented by loan default leakage. In a report, Deloitte points out that the Department of Labor (DOL) states that loan programs should not diminish a borrower’s retirement income or cause loss to the plan, and views loans as investments, requiring the same fiduciary oversight as any other plan investment option. “Yet, in practice, loans are viewed as an administrative burden passed on to the recordkeeper with minimal oversight. In the event of an economic downturn, borrowing tends to increase, and the magnitude of these losses grows, leaving fiduciary responsibility potentially exposed,” the report says.

The report explores mechanisms to prevent loan leakage, including policy changes to plan design, loan education programs, debt consolidation, payroll program automation, and 401(k) loan insurance.

According to the report, products retirement plan sponsors should consider, include:

• A suite of pre-tax wellness plans (e.g., health savings accounts, flexible spending accounts and 529 plans) as part of current benefit lineups;
• Debt-management programs for participants who are low-income and struggling to pay student debt, credit card debt and household debt;
• 401(k) plan loan insurance that automatically prevents loan defaults and consequences (taxes, penalties, anticipated cash-outs) due to involuntary job loss;
• Preapproved emergency loan options that allow automatic payroll deductions from a participant’s paycheck to assist with last-minute needs; and
• Rainy-day savings plans holding a fixed rate of return on a small percentage of payroll assets that are automatically deducted each pay period.

Loan policies to consider, include:

• Establish and enforce robust 401(k) education and loan risk awareness programs designed and curated for fiduciary responsibility, prior to lending approval;
• Reduce the permissible loan amounts and number of loans outstanding per participant, and increase flexibility in payback timelines; and
• Enforce waiting periods for plans that are currently designed with multiple loan originations and payoff dates, resulting in overall reduction of loans available.

In addition, Deloitte recommends that plan sponsors:

• Develop and deploy a custom and targeted strategic communications plan that enables a two-way conversation between employees and employers to better educate employees and support their needs;
• Develop applications to generate more informed, calculated decisions by employees based on assumptions of loan amounts—pending employee withdrawal;
• Enable automated post-separation repayment opportunities to allow defaulting participants to access and repay their loans, reducing the need for manual pay-back after a job loss; and
• Reduce manual processing by enabling auto-transfer participant rollovers from one plan to the next.

“Finding the right balance of product innovation, plan design and technology can help to collectively increase financial wellness and readiness for retirement,” the report says.