Navigant Economics’ Policy Brief Estimates Leakage of American Retirement Funds as High as $37 Billion Annually
Auto-Enrollment into Default Protection Provides a Sensible Solution
According to the brief’s authors, Drs.
“Of course, participants are not deliberately defaulting; they only do so when they have no other option,” commented Litan. “According to a study conducted by the Financial Literacy Center, almost 10 percent of all 401(k) participants with loans from 2005-08 defaulted on their loans for reasons relating to job separation.”
Because the 401(k) loan default rate in that sample (10 percent) was associated with an unemployment rate that is roughly half of today’s unemployment rate (4 percent versus 8 percent), and because 401(k) loan default rates are correlated with unemployment rates, Litan and Singer project significantly higher 401(k) loan default rates since the onset of the Great Recession in late 2008. Higher 401(k) default rates imply more leakage from Americans’ retirement accounts.
When a participant loses his/her job with a 401(k) loan outstanding, the loan is due in full in 60 days and failure to meet that accelerated time table results in substantial losses from the retirement account. From a policy perspective, some have recommended that limiting the number or size of loans or permitting the loan to be ported to a new plan provides a solution. While such prescriptions may reduce the likelihood of default, Litan and Singer conclude that none of these options provide liquidity and deal with the welfare of the borrower who actually defaults. Changing the law to allow automatic enrollment into loan protection provides an option that could stem the leakage currently impacting retirement savings by providing guaranteed coverage at an affordable rate. This would be analogous to the standard protocol that requires mortgagors who make smaller down payments to enroll in private mortgage insurance.
“There is a growing literature on the 'nudge' value of default rules. It has been shown, for example, that individuals are more likely to contribute to their own 401(k) in the first instance if the default rule is automatic contribution with an opt out rather than the previous opt in system,” Singer explained. “The same logic implies that 401(k) borrowers would be more inclined to protect their loans against involuntary default.”
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