401k Plan Leakage is Accelerating at an Understandable Pace

401k Plan Leakage

401k Plan Leakage is Accelerating at an Understandable Pace

401k Plan Leakage is negatively is impacting retirement savings however some of that can be expected.

As industry experts point out, automating retirement plan design did a great job of helping workers to accumulate savings.  Now, it’s a matter of preventing 401k plan leakage and keeping that money in employees’ retirement accounts.  The intent is to permit those retirement assets to grow and ultimately provide retirees with financial security in their post-career years.  Research from Alight Solutions as cited in The Wall Street Journal supports that a certain degree of 401k plan leakage can be anticipated since auto-enrollment has helped to boost average participation rates above 85%, compared to 63% for plans without the feature. With default deferral rates of around 3%, it has also helped to establish accounts with small balances.  This is in part, the product of today’s increasingly mobile workforce.

401(k) plan leakage occurs where participants withdraw their savings prior to reaching normal retirement age. The issue has been exacerbated by the widespread acceptance of auto-enrollment and auto increase features of 401 and 403b plans.  As auto-enrollment has helped millions of American workers to establish and increase their retirement savings, the downside is that it has also formed a pool of money that many are tempted to tap into before their working years are through.

According to the study, cited in The Wall Street Journal, within eight years of joining a 401(k) plan, auto-enrolled workers withdraw nearly half of the extra savings they manage to accumulate, compared to workers who are left to sign up for the plan themselves.

Many workers don’t see the value in rolling those balances over, so they end up cashing them out when they leave their employer, a primary culprit of 401(k) plan leakage. In fact, slightly more than 60% of 401(k) participants with balances of less than $10,000 cash out their savings and pay income taxes and usually a 10% early withdrawal penalty, rather than leaving their money where it is or rolling it into another tax-qualified retirement plan, according to Retirement Clearinghouse, again cited in the WSJ.

Workers who remain with their employers face another type of 401(k) plan leakage — loans. Sources interviewed in the WSJ said that auto-enrolled workers are more likely to borrow from their retirement plan balances. Moreover, while most 401(k) borrowers repay themselves with interest, around 10% default on about $5 billion every year. Clearly, that’s a significant blow to their retirement preparedness.

As a practice, automatic enrollment is positive for plan participants.  It is intended to increase retirement plan participation and savings rates and it has proven to do so very effectively. Now, the issue policymakers, retirement advisors, and plan providers should focus on is How to help employees preserve the integrity (account balances) that have accumulated in participants’ retirement savings accounts.   How to limit 401k plan leakage.

Wholistic Financial Wellness programs may also be a solution to reducing the magnitude and instances of 401(k) plan leakage. These programs offer education and advice on various aspects of basic financial management.  Plan sponsor employers and plan participants have made substantial progress.  A plan for continuing that progress needs to incorporate additional choices that restrict 401k plan leakage.

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