Industry Voices

A Forgotten Part of Participant Financial Wellness: Loan Defaults

Loan defaults are a preventable form of plan leakage, and stopping them can improve retirement plan participants’ financial wellness.

By PS | May 17, 2017
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With all the industry focus on financial wellness, it begs the question. Why do plans ignore an ongoing source of retirement plan leakage: defined contribution (DC) plan loan defaults? 

Access to plan loans is a widely-acknowledged necessity, since loans are known to encourage higher participation and contribution rates.  When retirement plan participants need emergency cash, they are required by regulation to take a loan before a hardship withdrawal to prevent immediate plan leakage. Yet if loans always default on termination, what does this accomplish?  Certainly not financial wellness. 

Loan defaults hurt participants during an already stressful time 

Involuntary job loss caused by death, disability, or unemployment triggers defaults on unprotected loans, causing the same leakage as cash outs.  While unintentional, this negatively affects retirement outcomes, especially during layoffs. 

According to Challenger, Gray & Christmas, layoffs were at a seven-year high in 2016. Think about it: a participant’s account is diminished during an already stressful time when they’re out of work without income. Their retirement savings and future income are now at risk.

A bigger problem than plan sponsors realize  

The facts are sobering: According to a Wharton/Vanguard study, 86% of loans default upon job loss. These defaults often trigger full cash outs leading to even greater retirement leakage.  Unprotected DC plan loans leave a hole in the retirement safety net, causing an estimated $6 billion in annual leakage, and $30 billion when associated cash outs are included.  Is there a way to avoid this vicious cycle?  New industry developments suggest there is.

NEXT: Solutions for preventing loan defaults