401(k) Loans Cause Stress Over Potential Job Loss

Inside Subprime: October 30, 2019

By Lindsay Frankel

Employers are equipped to offer a range of financial wellness benefits, from financial education to instant wage access, in order to assist workers with financial emergencies. And many Americans are in need of a financial tool to cope with unexpected expenses; 39 percent would not be able to handle a $400 emergency cost without borrowing money or selling belongings, according to the Federal Reserve.

However, one benefit that employees utilize has the potential to be dangerous in the case of job loss, and that’s causing workers greater stress. According to a new study from market research firm Greenwald & Associates, 91 percent of employees appreciate the option to borrow from their 401(k) plans, yet 70 percent worry that losing their jobs would make it hard to pay back what they owe.

For the 20 percent of 401(k) participants that have an outstanding loan, job loss could prove to be even more financially damaging. That’s because when employees with 401(k) loans are laid off, they need to pay the entire amount back at once in order to avoid default and associated penalties.

The study also found that one quarter of respondents took out a 401(k) loan to make ends meet, while 23 percent used the money to pay off credit card debt and 22 percent put it towards medical expenses not covered by insurance.

The study indicates that employers should be addressing these issues in addition to making 401(k) loans available. And, there’s a need for more security surrounding these loans. Automated loan insurance could be a solution to the problem, and more than half of survey respondents said their employers should add the option. Of the 70 percent of survey participants who reported feeling financially stressed, 80 percent said loan insurance would help ease their worries.

“The survey data and interviews with participants clearly show that 401(k) borrowers are under a great deal of financial stress,” said Brian Perlman, Senior Vice President and Financial Service Practice Lead for Greenwald & Associates. “To illustrate what participants are facing, one woman I interviewed took out a loan from her 401(k) to help her pay out-of-pocket medical costs related to her fibromyalgia. She was later forced to go on disability as a result of her illness and defaulted on her loan. She—and other borrowers—needs a better safety net.”

But while 401(k) loans have their risks, there are worse methods of borrowing. For people who lack access to traditional forms of credit, a 401(k) loan is a better choice than a payday loan. Payday loans have short terms and high interest rates, making them difficult for borrowers to repay in the time allotted. These loans are especially risky in states that do little to regulate the industry. For example, payday loans in Idaho have an average APR of 582 percent, the highest in the nation.

Still, borrowers should consider other alternatives before taking out a 401(k) loan, and employers should continue to pursue alternative forms of financial assistance to help borrowers avoid the risks of both payday loans and 401(k) loans.

Learn more about payday loans, scams, and cash advances by checking out our city and state financial guides, including Chicago, Illinois, Florida, Texas, and more.