The National Collegiate Athletic Association’s (NCAA) winner-take-all tournament to decide the top college basketball team in the country is so exciting, with smaller schools often staging upsets over larger rivals in these single elimination contests, that the tournament has come to be referred to as “March Madness.”
The nature of sporting contests is to separate winners and losers. It’s why we watch. Because no matter how much any one person or team prepares, or how hard they try, they can still lose the game and be eliminated. Retirement planning is supposed to work differently; a successful retirement has always been presented as more of a journey that anyone can complete: Save enough money, invest wisely, and the rest will take care of itself.
The industry often publishes material that shows how easy a successful retirement plan can be if someone just follows the rules. Save at least 10% of your pay each year. Take advantage of any and all employer matches. Invest for the long term, maybe with a diversified target-date fund (TDF) that matches the year you turn 65. Financial news website CNNMoney’s “millionaire calculator” shows that anyone can become a millionaire in 40 years by saving $500 each month and earning 6% on their investment (any employer contributions in a 401(k) style plan will only add to that total), so the math seems to check out.
A Game of Chance
The problem? Back to the basketball court for a lesson on chance. Things will happen unexpectedly during a game, such as a late turnover or an injury, that cannot be controlled for, no matter how much planning takes place. And it is these events that can cause a team to throw the playbook out the window and leave them hoping for that last big shot at the end to win the game. Sometimes these shots fall, other times they bounce off the rim. Thankfully, it’s only a game.
But chance isn’t only a factor in sports. Chance also comes into play on the road to retirement. Millions of workers reluctantly borrow from their retirement plans every year to meet unexpected financial needs, taking advantage of payroll deduction repayments and much lower rates than they might find in consumer loan markets, provided they even qualify. But chance doesn’t stop there. The CNN Money calculator assumes 40 years of uninterrupted work. Yet the Department of Labor (DOL) reported more than 20 million workers were discharged last year alone, losing their jobs to layoffs or other factors outside their control, such as injuries, during the strongest job market on record. It is when these two chances come together that people stop winning at retirement.
The Pension Research Council found that 86% of 401(k) loans, almost nine in 10, default after separation. When that separation is involuntary, and workers are deprived of their source of income, they are not in a position to take advantage of any extended payment terms their former employer might allow. The net result, according to consulting firm Deloitte, is that an average $7,000 loan default followed by a full cash out of the remaining balance to pay taxes and penalties will forfeit up to $300,000 in future retirement value. That’s a deficit you don’t come back from, especially if it happens in the “second half” of your career.
Workers with 401(k) loans that choose to change employers on their own can be expected to plan for their loan; after all, they still have income and agreed to do this when they borrowed the money. Similarly, employees without retirement plan loans that lose their jobs in a downsizing or to injury can benefit from unemployment insurance and severance benefits while they search for their next position. But the confluence of these events—when one of the 20 million workers losing his job has a retirement loan outstanding—almost certainly causes loans to default and puts retirement security in serious jeopardy.
Stopping the Madness When It Comes to Retirement Security
Fortunately, there are solutions available that can provide more retirement security to what is likely millions of workers. First, plan sponsors can offer extended post-termination loan repayment via automated clearing house (ACH) payments; however, this feature may not be feasible for workers who have lost a job and don’t have income. A better safety net for them may be the addition of low-cost loan insurance as a term in their plans’ loan policies, protecting their retirement accounts against job loss while still keeping rates low. These programs automatically protect loans as money is borrowed and repay the outstanding balance if an employee loses his job.
Fiduciaries can now eliminate the chance that millions of workers will lose out on a secure retirement for reasons outside their control. Coaches cannot buy insurance to protect their teams against a late game injury. I guess that’s one reason they call it madness.
George White is chief operations officer at Custodia Financial, which offers a product, Retirement Loan Eraser, that helps prevent 401(k) plan loan defaults before they occur. Previously, George held management positions at the Newport Group, RNC Capital and Fidelity Investments.
This article was written prior the announcement by the NCAA to cancel this year’s March Madness basketball tournament.
 “Borrowing from the Future: 401(k) Plan Loans and Loan Defaults,” Wharton/Vanguard Study, 2014
 “Loan leakage: How can we keep loan defaults from draining $2 trillion from America’s 401(k) accounts?”, Deloitte, October, 2018.
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