By Mark Olsen, Managing Director at PlanPILOT
The use of loans within employer-sponsored retirement savings plans (commonly known as 401(k) loans) has transitioned from a rare emergency measure to a frequently used financial tool. Driven by rising cost-of-living pressures and insufficient emergency savings, loan usage has seen a consistent upward trend, surging 20% compared to 2022 levels. While these loans can offer short-term relief to employees, they present significant long-term risks to retirement readiness, often creating a “leakage” effect that erodes retirement stability.
At PlanPILOT, we believe that taking a proactive approach in understanding and mitigating these types of issues can help to maintain a robust and beneficial retirement plan for participants. Let’s take a look at the growing trend of participant reliance on retirement plan loans, how they can hamper retirement readiness, and potential solutions that can help solve this problem.
The Growing Trend: A Symptom of Financial Strain
Recent data highlights a steady increase in 401(k) loan activity. Studies indicate that as of late 2025, nearly 20% of participants had an outstanding loan from their retirement accounts. Average loan balances have also risen, with surveys placing them around $10,778, suggesting that participants are tapping into larger portions of their savings.
This trend is driven by a lack of accessible cash for emergencies. 60% of participants report being uncomfortable with the amount of emergency savings they have, likely making their 401(k) the only other available source of funds. Furthermore, the SECURE 2.0 Act, while promoting savings, has introduced provisions like penalty-free hardship withdrawals and relaxed rules that can inadvertently make it easier for employees to treat their retirement accounts as bank savings accounts.
Long-Term Impact on Retirement Readiness
While 401(k) loans are repaid with interest, that interest is paid back to the participant’s own account, making them seemingly harmless. However, the true damage to retirement readiness stems from two primary factors: lost opportunity cost and default risks.
- Opportunity cost (lost growth): Money borrowed from a 401(k) is removed from the investment markets. During the loan period, that cash is not growing, meaning it misses out on potential compound investment gains. Given that loans can be outstanding for five years or more, this “lost time” can significantly reduce the final account balance at retirement, requiring higher future contributions to realize the same retirement goals or working longer than expected.
- Default upon job change: A critical, often overlooked risk is the repayment requirement upon leaving a job. If an employee leaves or loses their job with an outstanding loan balance, they usually have a short window to repay it, or the loan defaults. A defaulted loan is treated as a taxable distribution, subjected to income taxes and, for those under 59½, a 10% early withdrawal penalty. Almost 40% of workers take a loan at some point, and 86% of those who change jobs do so with a loan default on the balance, per a 2019 study.
- Reduced contributions: Although some research suggests contributions remain relatively stable after taking a loan, a subset of borrowers (roughly 26% in some studies) do decrease their contribution rates to accommodate loan repayments, thus further hindering their accumulation of savings. This points to the notion that participants are living “on the edge” of their income and savings capacity with little cushion for contingencies.
Solutions for Plan Sponsors to Mitigate Risks
Plan sponsors must balance providing flexibility to employees with their fiduciary duty to promote the long-term success of the retirement plan. Here are strategies to mitigate the downsides of 401(k) loans:
- Establish emergency savings accounts (ESAs): Implementing SECURE 2.0 provisions for pension-linked emergency savings accounts allows employees to build a “rainy day” fund alongside their retirement contributions. This may reduce the need to borrow from retirement funds to pay for unexpected expenses.
- Implement loan waiting periods: Introducing a mandatory waiting period for new hires or limiting the number of loans a participant can have outstanding at once (e.g., limiting to one loan) can discourage routine borrowing.
- Encourage continued contributions: Design plans so that participants must continue to make elective contributions during the repayment of a loan. Some plan designs allow for automatic contributions to continue uninterrupted.
- Enhance financial wellness programs: The root cause of most loans is a lack of financial literacy and liquidity. Providing robust financial wellness tools, including education on budgeting, debt management, and the high cost of defaulting on a 401(k) loan, can help employees build resilience before they encounter a crisis.
- Add non-loan financial products: Offering employer-negotiated, low-interest emergency loans through a third party can prevent employees from tapping into their retirement plans.
Plan Sponsors Must Understand the Downside of Participant Loans
401(k) loans are a double-edged sword. While they offer necessary liquidity for employees facing financial hardship, the long-term cost to their retirement readiness is often high. By shifting the focus to holistic financial wellness and providing alternative emergency resources, plan sponsors can help employees bridge the gap between financial stability today and confidence tomorrow, keeping 401(k) plans vehicles for retirement rather than short-term funding sources.
Are Loans a Problem in Your Retirement Plan? Talk With Us.
At PlanPILOT, we’re creating the standard for client experience. Independent and impartial by design, we apply our skill to each facet of plan development, governance, and implementation to help you enjoy meaningful results. Our client partnerships are built on trust, communication, and responsibility—cornerstones of a healthy, prosperous relationship. We’re committed to providing objective guidance, informed innovation, and an integrated approach tailored to your unique objectives.
Our team of seasoned professionals upholds the highest professional standards, so every strategy we recommend aims to support both your organization and the participants who depend on it.
To learn more about how we can help with fiduciary oversight and improving the effectiveness of your benefits program, reach out to us at (312) 973-4913 or send an email to mark.olsen@PlanPILOT.com to learn more about how we can customize our services and your plan to fit your unique needs.
About Mark
Mark Olsen is the managing director at PlanPILOT, an independent retirement plan consulting firm headquartered in Chicago. PlanPILOT delivers comprehensive retirement plan advisory services to 401(k), 403(b), and 457 plan sponsors. His specialties include plan governance, investment searches, investment monitoring, and plan oversight. Mark is recognized as a leader in the industry and speaks at national conferences, including those organized by Pensions & Investments, and CUPA-HR.