$6 billion of 401(k) loan defaults each year

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The529guy
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$6 billion of 401(k) loan defaults each year

Post by The529guy » Tue Apr 21, 2015 11:45 pm

An article of interest from The Atlantic:

The Danger of Borrowing Money From Your Future Self

Excerpt:
Timothy (Jun) Lu, Olivia S. Mitchell, Stephen P. Utkus, and Jean A. Young, the authors of the study, found that about 90 percent of those who take out loans manage to repay them—except in the case of those who have outstanding loans when they exit a job. In those instances, about 86 percent of borrowers end up defaulting on their loans. After leaving a company, outstanding loans usually become due as a balloon payment within a short period of time, generally about 60 days. The authors suggest several explanations for the high default rate in such scenarios, including inattention to the loan and lack of knowledge about how these loans work when factoring in a job change. In total the study found that borrowers would [wound?] up with about $6 billion of 401(k) loan defaults each year.

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HardKnocker
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Re: $6 billion of 401(k) loan defaults each year

Post by HardKnocker » Wed Apr 22, 2015 6:42 am

There can be good reasons to borrow from a 401k but generally it is a poor financial decision.

Using 401k funds or home equity to finance consumer purchases is very bad. I have acquaintances who have done this repeatedly.
“Gold gets dug out of the ground, then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility.”--Warren Buffett

nordlead
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Re: $6 billion of 401(k) loan defaults each year

Post by nordlead » Wed Apr 22, 2015 6:53 am

no shocker there. People take out a loan and only consider how long they have to repay it, not what will speed up the pay by date. Also, if you took a loan it is probably because you don't have other money available. If you are laid off or change jobs you'll have no way to repay the loan.

gbru316
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Re: $6 billion of 401(k) loan defaults each year

Post by gbru316 » Wed Apr 22, 2015 7:58 am

nordlead wrote: If you are laid off or change jobs you'll have no way to repay the loan.
This happened to me in my less responsible days. Borrowed 3k out of my 401(k), got laid off in the middle of repayment. 401(k) manager then considered it a distribution and I had to pay the taxes on it that year.

Alan S.
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Re: $6 billion of 401(k) loan defaults each year

Post by Alan S. » Wed Apr 22, 2015 1:24 pm

gbru316 wrote:
nordlead wrote: If you are laid off or change jobs you'll have no way to repay the loan.
This happened to me in my less responsible days. Borrowed 3k out of my 401(k), got laid off in the middle of repayment. 401(k) manager then considered it a distribution and I had to pay the taxes on it that year.
Probably a 10% penalty as well.

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hand
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Re: $6 billion of 401(k) loan defaults each year

Post by hand » Wed Apr 22, 2015 2:04 pm

While I'm in agreement that easy debt (from 401(k), equity loan or otherwise) is financial dynamite to many with spending / savings / financial management problems, I do see a place for these loans in specialized cases.

That being said, the $6B in "defaults" strikes me as a sensationalized number - absolute worst case, financial impact of these "defaults" is that defaulters pay penalties of10% $600M (number likely lower as penalties not required in all cases), have their total tax advantaged savings space permanently reduced (typically only an issue for those who aren't simply worried about ability to retire), pay tax on the income now rather than later, and have a bit less in retirement savings. I am not clear the number of borrowers who share in the 10% penalty, but would imagine it comes out to something less than $5k / per "defaulter ($50k being a typical 401(k) borrowing limit).

While these are all negatives, there is no way to know the benefit gained by the "defaulters" by accessing their money - if the 10% penalty and the other negatives allowed me to keep my house or pay for medical bills, I might see this as a good deal.

Tamales
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Re: $6 billion of 401(k) loan defaults each year

Post by Tamales » Wed Apr 22, 2015 2:12 pm

FWIW, the data from a 2013 IRS report on 401k compliance seems to be a bit different:

Summary of 401k stats related to loans:

Hardship Distributions and Loans
• Seventy-six percent of section 401(k) plans permit hardship distributions.
• Very large plans are more likely than small or medium plans to allow hardship distributions.
• Sixty-five percent of section 401(k) plans allow participant loans.
• Very large plans are more likely than small, medium or large plans to allow loans.
• Forty-seven percent of section 401(k) plans saw an increase in the number of outstanding participant loans from 2006 to 2008.
• Sixty percent of section 401(k) plans saw an increase in the number of defaulted participant loans from 2006 to 2008.

snipped from: http://www.irs.gov/pub/irs-tege/401k_final_report.pdf

What exactly happens when someone defaults on a 401k loan? Can it impact fund management costs to remaining participants? What benefit is there for a company to allow 401k loans beyond hardship cases?

bigred77
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Re: $6 billion of 401(k) loan defaults each year

Post by bigred77 » Wed Apr 22, 2015 3:04 pm

That's negative news that such a high number of people are defaulting like that.

401k loans aren't inherently bad though.

Bigred77 the borrower can access a loan up to 50k, paid back anywhere from 1 - 4 years, with a 4.25 interest rate, minimal fees, no prepayment penalty, and can usually get the money in under 7 days.

Bigred77 the lender can loan up to 50k that he would have had invested in bonds yielding much lower than 4.25%, to someone he believes is credit worthy.

The job security is a risk for sure though. One that's very hard to quantify or make truly accurate, unbiased assumptions about.

awval999
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Re: $6 billion of 401(k) loan defaults each year

Post by awval999 » Wed Apr 22, 2015 4:49 pm

hand wrote:While I'm in agreement that easy debt (from 401(k), equity loan or otherwise) is financial dynamite to many with spending / savings / financial management problems, I do see a place for these loans in specialized cases.

That being said, the $6B in "defaults" strikes me as a sensationalized number - absolute worst case, financial impact of these "defaults" is that defaulters pay penalties of10% $600M (number likely lower as penalties not required in all cases), have their total tax advantaged savings space permanently reduced (typically only an issue for those who aren't simply worried about ability to retire), pay tax on the income now rather than later, and have a bit less in retirement savings. I am not clear the number of borrowers who share in the 10% penalty, but would imagine it comes out to something less than $5k / per "defaulter ($50k being a typical 401(k) borrowing limit).

While these are all negatives, there is no way to know the benefit gained by the "defaulters" by accessing their money - if the 10% penalty and the other negatives allowed me to keep my house or pay for medical bills, I might see this as a good deal.
Exactly. How can I "default" on money that is already mine. One cannot default on a 401k loan. Instead it is reclassified as an "unqualified distribution" or whatever. Typical sensationalism.

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Re: $6 billion of 401(k) loan defaults each year

Post by LadyGeek » Thu Apr 23, 2015 9:10 pm

This thread is now in the Personal Finance (Not Investing) (loan defaults). Regardless if this article is a mix of general investing (where the thread was originally located) and personal finance (loan management), the discussion is off-topic as a non-actionable troll (no clear conclusion, the discussion will soon devolve into contentious disagreements).

This thread has run its course and is locked (stupidity of others). See: Forum Policy

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