The $210 Billion Risk In Your 401(k) (#GotBitcoin?)
Annual defaults on loans taken against investors’ 401(k)s threaten to reduce the wealth in U.S. retirement accounts by about $210 billion when the lost savings are compounded over employees’ careers.
Annual defaults on loans taken against investors’ 401(k)s threaten to reduce the wealth in U.S. retirement accounts by about $210 billion when the lost savings are compounded over employees’ careers, according to an analysis by Deloitte Consulting LLP.
The projected future loss amounts to about 2.7% of the $7.8 trillion currently in 401(k)-style retirement accounts.
The numbers highlight the problem of tapping 401(k) savings before retirement, known in the industry as leakage.
Most leakage occurs because about 30% to 40% of people leaving jobs elect to cash out their accounts and pay taxes or penalties rather than leave the money or transfer it to another 401(k) or an individual retirement account.
But employees also take out loans, which about 90% of 401(k) plans offer. Workers can generally choose to borrow up to half of their 401(k) balance or $50,000, whichever is less.
About one-fifth of 401(k) participants with access to 401(k) loans take them, according to the Investment Company Institute, a mutual-fund industry trade group. While most 401(k) borrowers repay themselves with interest, about 10% default, or fail to repay their accounts, triggering taxes and often penalties, according to research by authors including Olivia Mitchell, an economist at the University of Pennsylvania’s Wharton School.
Failing to restore the funds typically occurs when employees with outstanding 401(k) loans leave companies before fully repaying their balances.
Money lost to 401(k) leakage, including loan defaults and cashouts, reduces the wealth in U.S. retirement accounts by an estimated 25% when the lost annual savings are compounded over 30 years, according to an analysis by economists at Boston College’s Center for Retirement Research.
Even those who successfully repay 401(k) loans can end up with less at retirement than they would have had. One reason is that many borrowers reduce their 401(k) contributions while repaying their loans.
While 401(k) loan defaults currently amount to about $7.3 billion a year, the impact is far greater given that many borrowers in default withdraw additional money to cover the taxes and early-withdrawal penalties they owe on their outstanding balances, says Gursharan Jhuty, senior manager at Deloitte Consulting.
About two-thirds of participants who default liquidate their accounts, he adds.
As a result, Deloitte projects that those who default on loans worth $7.3 billion this year will drain about $48 billion from their retirement accounts. If the $48 billion were to remain in their accounts, it would be worth $210 billion by retirement age, assuming a 6% annual return, Deloitte calculated.
Few employers are willing to eliminate 401(k) loans, in part because academic studies have shown that they encourage 401(k) plan participation.
But Deloitte, which offers consulting services to 401(k) and traditional pension plans, recommends that companies consider ways to reduce workers’ use of loans—steps many companies are starting to take.
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