401(k) Word Cloud (Image: Shutterstock)

Loans from 401(k)s, known as “leakage,” will spark a potential $2.5 trillion shortfall in retirement account balances, according to analysis released Wednesday by Deloitte.

The Deloitte research — which used estimates in loan defaults, future withdrawals and lost opportunity costs projected from a participant at age 42 until age 65, and is based on a 10-year business cycle — estimates $7.3 billion in loan defaults in 2018 alone.

Deloitte projected earlier academic and private market research from 2006 to 2018 using information from the Department of Labor’s Private Pension Bulletin on growth and plan participation.

In its latest research, Deloitte also factored in an investment return of 6% to come up with the $2.5 trillion projected shortfall figure.

Leakage, Deloitte warns, could not only harm retirement savings for many but cause a “significant detriment” to investment markets in the U.S. if there are no solutions or guardrails put in place to stem the tide.

“This potential retirement shortfall is likely to produce a considerable shift in standards of living during a period where participants are lacking employment income and relying upon their nest eggs,” Deloitte warned in its Retirement Plan Loan Leakage paper.

Taking the 42-year-old borrower who defaults on a retirement account loan of $7,000 and then cashes out the remaining account balance of $70,000, Deloitte’s analysis found that the borrower would be sacrificing $217,647 in lost investment return.

Deloitte pointed out that Pension Research Council statistics found that a whopping 86% of participants defaulted on their loans after leaving employment.

The paper proffers some potential mechanisms to prevent loan leakage, including new products and policies.

These products would include 401(k) loan insurance that would automatically prevent not only the defaults but the accompanying taxes and penalties that could lead up to cash-outs from job loss, emergency loan options, rainy-day savings plans with a fixed return rate on a fraction of salary deducted each pay period, and pretax wellness plans in benefit suites.

Policies recommended by Deloitte include education and awareness programs on employer retirement plans and on-site advice designed for the needs of the employee, reduction in the allowed loan amounts and in their frequency, more flexibility in paying back the loans and enforcement of waiting periods for more loans with multiple origination and payoff dates.

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