More companies are giving departing employees the option to continue paying off their 401(k) loans in installments instead of having to pay them in full before leaving.
"Plan sponsors say, 'If there's a way to allow people to pay us back over time — kind of like how the original loan was first set up — let's go ahead and do that,' " said Rob Austin, the Charlotte, N.C.-based head of research at Alight Solutions.
Indeed, the number of employers permitting former employees to continue paying off their loans has grown significantly over the past few years. In 2018, about 43% of plan sponsors offered this option, up from 13.3% in 2016, according to Callan LLC.
For Hilton Worldwide Holdings Inc., the decision to add the feature was easy, said Casey Young, the company's Memphis-based director of global retirement programs. "If we can allow participants a flexible option to repay the loans, we should do so," he said of Hilton's decision in 2013.
More importantly, he said, the loan repayment option would prevent many participants from defaulting on their loans, an event that could significantly erode their retirement savings.
Participants often default because they are unable to repay their loans within 60 to 90 days after leaving their companies — the typical window that most companies require.
As a result, they are hit with federal and state taxes on their loan balances plus a 10% early withdrawal penalty if they're younger than 59 ½. Making matters worse, many are forced to cash out their entire 401(k) accounts to satisfy loan obligations, slashing their long-term retirement prospects.
"They took the loan because they don't have the money, and so if we require them to pay back this large sum at once, it doesn't really naturally follow that they have the money to pay it back," Mr. Young said.
Most defaults occur when workers leave their employers, said Olivia Mitchell, a professor of business economics and public policy and executive director of the Pension Research Council at the University of Pennsylvania's Wharton School in Philadelphia.
In a study published in the National Tax Journal in March 2017, Ms. Mitchell and co-authors Timothy (Jun) Lu, Stephen Utkus and Jean Young found that 86% of employees who have 401(k) loans when they leave their jobs default because employers tend to require repayment in full.
For participants, the lost retirement savings can be significant. In a report last year, Deloitte calculated that $2.5 trillion in potential future account balances will be lost due to loan defaults from 401(k) accounts over the next 10 years. The estimate represented the cumulative effect of loan defaults, including taxes, early withdrawal penalties, lost earnings and early cashouts of participants' full plan balances.
By Deloitte's projections, this represents roughly $300,000 in lost retirement savings for a typical defaulting borrower over his or her career.