How 401(k) Loans Impact Employee Financial Wellbeing

In today's challenging financial landscape, a growing number of employees are resorting to 401(k) loans.

While 401(k) loans can provide temporary relief, they bring long-term consequences that hinder employees' financial stability and retirement readiness.

In this blog, we'll cover:

• The latest stats on 401(k) loans
• Why employees take loans from their retirement accounts
• How the terms of a 401(k) loan compare to other types of loans
• The negative impacts of 401(k) loans on employee financial health
• Strategies for employers to take action, and more

The Latest Statistics on 401(k) Loans 

Nearly one-third (29 percent) of Americans who participate in a 401(k) or other defined contribution retirement plan say they have taken out a loan from the savings in their plan.

Why do employees take 401(k) loans?

Employees of all income levels take 401(k) loans for various reasons, including:

• Financial emergencies
• Debt consolidation
• Large purchases
• Making ends meet
• Other personal financial needs

How much is the average 401(k) loan?

According to Bank of America, the average 401(k) loan amount is $8,550 -- an increase of 14% within this year, alone. 

Are employees paying back their 401(k) loans?

The latest data from Debt.org shows that nearly 16% of borrowers have a 401(k) loan in default. This means that the borrower has failed to meet the loan agreement terms established by the retirement plan. In many cases, defaulting on a 401(k) loan requires the outstanding balance to be repaid in full. This can create a financial burden for the borrower, especially if they are unable to repay the loan at once. Being in default can also have steep tax implications, penalties, and fees. 

How do the terms of a 401(k) loan compare to other types of loans?

For the average employee, taking a 401(k) loan costs more over the life of the loan. The 401(k) loan rate is usually a point or two above the prime rate, which is the interest rate commercial banks charge their most creditworthy customers. This can lead to hundreds of dollars in extra costs over the duration of the loan.  

How 401(k) Loans Negatively Impact Employee's Financial Wellbeing

Lost investment growth

401(k) loans reduce retirement account balances by an average of 13% over a 30-year period.

Reduced contributions

Participants who took out a loan contributed less to their 401(k) in the subsequent years compared to those who did not borrow.  

Financial penalties and taxes

Failure to repay the 401(k) loan within the specified timeframe or leaving a job triggers taxes and potential penalties. Early withdrawals from a 401(k) before the age of 59 ½ are generally subject to a ten percent early withdrawal penalty in addition to regular income tax. These taxes and penalties further erode employee's retirement savings.

Increased financial stress

Taking a 401(k) loan may provide temporary relief by supplying funds for immediate needs. However, the burden of repaying the loan, along with interest, penalties, and fees, can create additional financial stress for the employee. Juggling loan repayments with other financial obligations can lead to a cycle of debt and financial instability.

Delayed retirement

Employees who withdraw from retirement savings early through loans disrupt their long-term financial planning. This may necessitate working longer to compensate for the reduced nest egg. This delay can have implications not only for individual retirement security but also for broader workforce dynamics and retirement trends.

Employers Can Take Action to Reduce 401(k) Loans

The prevalence of 401(k) loans among employees underscores the need for proactive solutions to safeguard long-term financial stability. While 401(k) loans may offer a quick fix for pressing financial needs, the ripple effects can significantly impact retirement readiness and overall financial wellbeing.

The consequences of 401(k) loans are complex and the burden of repayment amplifies financial stress, perpetuating a cycle of debt and instability.

However, innovative financial wellbeing solutions are now addressing the root causes of 401(k) loan dependency and fostering a culture of financial resilience. With a trusted financial wellbeing program by their side, organizations can empower employees to navigate financial challenges effectively.