Recent news stories about the dangers of taking a 401(k) loan are missing the real story. Borrowing from a 401(k) plan isn’t necessarily a bad thing. Employers offer loans in 401(k) plans because this feature gives many the confidence to participate in the first place. Plan sponsors know this.
Borrowing from your retirement plan isn’t the problem. The issue is if you don’t pay it back. That’s the truth the media is overlooking: loan defaults.
A little context: Fully twenty percent of employees borrow from their accounts when they need money, and it’s hard to blame them. The interest plans charge is often much lower than consumer loans.
Recent stories suggest that because some workers stop contributing to the plan when they borrow, loans are problematic. This simple view ignores the fact that the person taking a loan needed the money and would have borrowed outside the plan at higher rates if a plan loan was not available.
Loan programs do add risk, though: the risk of default. This risk is high – especially if employees lose their jobs. Fully 86% of employees with outstanding loans default upon job loss and, with the financial stress they are under, over 65% of borrowers go on to cash out their accounts entirely.1
This behavior can be catastrophic when you factor in the impact of taxes, penalties and lost earnings over someone’s working career. A $5,000 loan default today costs the typical borrower more than $20,000 at retirement, and could cost more than $100,000 in future retirement savings if they withdraw their remaining funds after a layoff.
Isn’t money employees have worked hard to save for retirement worth protecting? An independent company of 401(k) thought leaders thinks so. That’s why Custodia Financial provides simple 401(k) loan insurance for plan sponsors. Retirement Loan Eraser (RLE) insures the repayment of a participant’s loan when they borrow from a 401(k) plan.
This affordable program can be added at no cost to the plan sponsor, and participants incur cost only if they decide to borrow from the plan. A typical premium runs only $4 to $6 per paycheck.
Adding 401(k) loan insurance to a plan reduces fiduciary risk for plan sponsors. The universal participant insurance coverage kicks in due to involuntary job loss, death, or disability.
When it comes to 401(k) loans, job losses and subsequent loan defaults are the real problem. With the availability of 401(k) loan protection, now there is a bright side to the story.
1 Wharton-Vanguard Study, 2014
About the author:
George White is a financial services industry executive who has spent his career managing and advising employee retirement benefit plans. Contact the author at email@example.com or follow his company on LinkedIn.