COVID-19 is causing an extraordinary and unprecedented economic disruption. As we’ve been seeing around the world, effectively mitigating both short- and long-term impacts requires decisive action, not just in terms of epidemiology, but also economics and business. Decisions made–or options ignored–will have lasting impact. The Federal Reserve recently slashed interest rates to zero as part of a wide-ranging emergency intervention, and the largest-ever economic stimulus bill was just signed into law. But the layoffs have already started, and the consensus is that, even with a continued robust response from government, layoffs will accelerate. In fact, the Department of Labor reported that roughly 17 million Americans applied for unemployment in just the last three weeks.
For several years, many employers have focused on “financial-wellness” programs presumably meant to increase employees’ ability to withstand a financial shock. However, the uptake and effectiveness of such programs has been limited, as many have relied on education and “opt-in” participation. Through a period of unrelenting economic growth and record unemployment, many people haven’t been paying attention. Life has been good. Automated solutions that can be quickly implemented are ideal, such as 401(k) plans that automatically enroll new hires, but few financial-wellness programs have been constructed in this way.
One acute financial-wellness problem that should be on the C-suite agenda immediately is the issue of 401(k) loan defaults. We know from research that if an employee is laid-off with a 401(k) loan outstanding, default is virtually guaranteed, triggering income taxes, a 10% penalty if the employee is under 59½, and significant lost earnings. A recent study estimated that the average defaulting borrower will lose $300,000 in retirement savings when taxes, penalties, potential cash-outs and lost earnings are considered. These cash-outs come into play when cash-strapped employees liquidate their entire accounts to cover taxes, penalties and other expenses they’re likely facing. That same study, published in late 2018, estimated 401(k) loan defaults to be a $2.5 trillion problem over the next 10 years, but the analysis did not contemplate an event-driven catastrophe like COVID-19. So, it begs the question: What did we learn from the Great Recession?
For employees’ sake, we need to make sure that the industry has a long memory. In 2008-09, the downturn was accompanied by significant increases in borrowing, layoffs and unemployment periods. Unfortunately, this created a negative “perfect storm” that caused even greater numbers of loan defaults. Immediately before the crisis, according to Fidelity, about 20% of participants had a loan outstanding; however, in the wake of the last financial crisis, the number of employees terminated with a loan outstanding spiked by nearly 25%. According to the Bureau of Labor Statistics, the average period of unemployment at the end of 2019 was under 22 weeks; it was nearly double that coming out of 2008-09.
With a Thoughtful Approach, This Is a Solvable Problem
So much is out of our control when it comes to retirement security. We can’t predict market booms, busts or acute catastrophic events like COVID-19. This is one issue, however, that we can control to a large degree. First, employers can offer extended post-termination loan repayment via automated clearing house (ACH) payments as a mechanism for laid-off workers to repay their loans over time, versus having to pay off the entire outstanding balance immediately after termination. This approach, however, may not be sufficient for a laid-off worker without income. A more secure safety net for them would be the addition of low-cost loan insurance as an integral feature in their plans’ loan policies, protecting their retirement accounts against job loss while still keeping borrowing rates low. These programs automatically protect loans as money is borrowed and repay the outstanding balance if an employee loses his or her job. In addition, despite recent moves to make access to 401(k) hardship withdrawals easier, employers should encourage the loan feature of their 401(k) plan as a preferred source of emergency liquidity. With loans, there is a good chance that the employee will repay the principal and maintain their savings, especially with insurance in place. With hardship withdrawals, leakage is permanent.
The Time to Act Is Now
We’re already seeing significant layoff announcements related to the effects of COVID-19. I wince every time I see one from an employer not yet offering automated 401(k) loan insurance. For reference sake, let’s do the math. David Wilcox, a senior fellow at the Peterson Institute for International Economics, estimates job losses of 3.5 million workers resulting from a recession driven by COVID-19. The data tell us that 90% of those 3.5 million workers will have access to loans; that’s 3.15 million workers, and roughly 20% of those will have loans outstanding–resulting in 630,000 workers laid off with 401(k) loans outstanding. The data also tells us that these laid-off workers are virtually guaranteed to default, so at $300,000 in average lost retirement savings per worker, that equates to roughly $200 billion.
Chuck Hill is the former CHRO of Pfizer Inc. While at Pfizer, one of the world’s largest research-based biopharmaceutical companies with over $50 billion in revenue, Hill was responsible for all enterprise human resource programs, including compensation and benefits. Pfizer’s primary savings plan is one of the largest 401(k)s in America, with approximately $14 billion in assets and over 50,000 participants. Prior to joining Pfizer, Hill served for eight years in the United States Air Force as an instructor fighter pilot and flight commander. At Pfizer, he supported veterans and active military by serving as the executive sponsor of the Pfizer Colleague Council, Veterans in Pfizer, which works to maximize the unique role that veterans and active military personnel play in driving workplace and marketplace outcomes. He is a member of Custodia Financial’s Strategic Advisory Council, which advises Custodia on a range of strategic issues, including product development, distribution, insurance and regulatory matters. Custodia Financial is the innovator behind Retirement Loan Eraser, an insurance technology solution that prevents loan defaults caused by layoff, disability or death.
Â Borrowing from the Future: 401(k) Plan Loans and Loan Defaults, Wharton/Vanguard Study, 2014.
Â Loan leakage: How can we keep loan defaults from draining $2 trillion from America’s 401(k) accounts?, Deloitte, October, 2018.
 https://www.cnbc.com/amp/2020/03/16/millions-of-americans-could-lFormer Pfizer CHRO weighs in with lessons from the Great Recession.ose-their-jobs-in-a-coronavirus-recession.html
Â “U.S. Economic Outlook Under Coronavirus Hinges on Layoff Decisions,” The Wall Street Journal, March 15, 2020.