PLANSPONSOR: Can you describe the
retirement plan loan default issue and
its significance for plan sponsors?
GEORGE WHITE: 401(k) plans are compromised by the leakage caused by loan
defaults. The issue is bigger than most
plan sponsors realize. A Wharton study
found that $6 billion in loans default
annually, and 86% of loans default when
participants lose their jobs and are unable
to repay. The majority go on to cash out,
and when you factor that in, you’re looking at over $20 billion dollars lost each
year. But it’s largely gone unnoticed
because only 8% of loan defaults are
separately reported on Form 5500. The
good news is this leakage is unnecessary and can be prevented
with simple loan insurance.
PS: What are the risks to plan sponsors if they ignore loan
WHITE: The risks are substantial. Loan defaults drain participants’ 401(k) accounts. The true cost of a loan default includes
taxes, penalties and associated cash outs, not to mention the
lost savings and earnings opportunity over a participant’s
career. The sponsor has greater fiduciary risk. Under the
Employee Retirement Income Security Act [ERISA] fiduciaries
are obligated to preserve account balances in the event of a
loan default, but the current practice of sending a collections
notice is ineffective because people who have lost their jobs
aren’t in a position to repay the loan. And plan sponsors are at
greater risk of an audit, based on a Department of Labor [DOL]
notice that loans are on their radar.
PS: Why did you pursue a product-based solution over some
other measures available to plan sponsors?
WHITE: Because we believe that while those measures are
well-intentioned, they don’t go far enough. Loans are an
essential feature for 401(k) plans because they create a path to
participation for many employees. Eliminating or restricting
loans can end up increasing your hardship withdrawals. Some
plan sponsors are beginning to allow ongoing repayment of
loans after termination. We’ve talked to firms that are doing
this and they’re not seeing a pickup in successful repayments
because most people that borrow don’t have the money to
repay, especially if they’ve lost their jobs.
The Risk of Overlooking
Retirement Plan Loan Defaults
A conversation with George White, EVP and COO, Custodia Financial, LLC
PS: Talk about Custodia’s solution to this
WHITE: Our program is called Retirement
Loan Eraser. When a participant loses his
or her job, it will repay the outstanding loan
balance before the participant defaults. It’s
a fully automated, seamless solution that
stops the leakage, especially the premature
distributions. The insurance is guaranteed
issue coverage through an A-rated carrier.
There is no cost to plan sponsors. The loan
protection is borrower-paid with just a few
dollars more added to a loan repayment.
When you consider the millions that the
industry has spent on financial wellness
without a clear return on investment, loan
insurance preventing 401(k) loan defaults makes sense. A plan
sponsor will be able to measure the positive impact on their
plan right away.
PS: Can you tell us more about how it works?
WHITE: Once a plan sponsor adds the program participants
automatically receive loan insurance when they borrow. By
preventing the loan default, 401(k) loan insurance allows
participants to keep their balance and their retirement savings
on track. The insurance kicks in and pays the loan balance for
three eligible events: involuntary job loss, disability or death.
So if a participant is laid off, for example, the policy would
repay the loan before it defaults, saving taxes, penalties and
lost earnings that can grow to exceed several times the loan
value. That improves retirement outcomes.
PS: How do plan sponsors add this to their plan?
WHITE: This simple loan protection feature is easy for plan
sponsors to adopt through their recordkeepers. Plan sponsors
can call Custodia Financial at 214-393-3511 or visit us online
at www.loaneraser.com to learn more.
George White is Executive Vice President and COO of
Custodia Financial. Mr. White has also held senior leadership
positions in the retirement business at Fidelity Investments
and Newport Group during his career.