401k Plan Leakage Puts Many of America’s Workers in a Precarious Position at Retirement
401k plan leakage is big business these days. Approximately 1.5% of assets “leak” out of retirement plans every year. 401k plan Leakage refers to the erosion of assets in retirement accounts. Leakage can potentially cause an employee’s retirement savings to decline by 20-25% over the course of their career, according to the Center for RETIREMENT RESEARCH at Boston College.
Most unnecessary cash-outs occur because of friction in the system (for example, the rollover process from one employer’s plan to another isn’t necessarily seamless or simple) or due to a lack of participant understanding and education. 401k plan leakage is permeating the retirement assets of plan participants. That equates to a lot of missed opportunities for employers who should be encouraging the preservation of retirement plan assets, and for participants looking to achieve their retirement goals.
Typically, when an employee with a 401(k) or similar retirement plan account leaves an employer, they have four options: roll it over to an IRA, keep the money in their former employer’s plan, roll their savings over to their new employer’s plan, or cash it out – which is considered 401k plan leakage. Government regulations mandate that account balances of less than $5,000 be rolled into a Safe Harbor IRA for workers who leave their employer and do nothing with the money.
Retirement plan cash-outs are a hefty problem for both employers and employees. According to data cited in a recent BenefitsPro article, 14.8 million retirement plan participants change jobs every year. Of these, 6 million, or 41%, will eventually cash out of their employers’ retirement plan. However, most of those cash-outs are unnecessary, BenefitsPro points out. Of the 6 million, 2.2 million — slightly more than one-third — will cash out their retirement savings for an actual financial emergency. That means 3.8 million participants will be party to 401k plan leakage or cash-outs which are completely unnecessary.
There has been much discussion over the years on the topic of auto-portability for small retirement plan account balances; that is, automatically rolling the balances into the employees’ next 401(k) if they don’t cash it out. According to the Employee Benefit Research Institute (EBRI), again cited by BenefitsPro, when applied to participants with balances of less than $5,000 EBRI’s Retirement Savings Projection Model projects that auto-portability would reduce the retirement savings shortfall by a whopping $1.5 trillion.
What can employers do? For starters, employers should help to improve their employees’ understanding of their workplace retirement plan benefits. Most employees don’t understand that tax-deferred savings, matching contributions, carefully vetted investments and lower institutional-level fees are only a portion of the plan benefits when it comes to their ability to save money for retirement. Asset retention starts with helping employees understand the value of having a company retirement savings plan. The plan should be promoted by the employer and recognized by the employees as the benefit it truly is.
It’s also important to help employees understand how to manage their retirement plan account balances after they leave an employer or retire. The standard HR exit interview usually details how employees can take their money out of the plan. Consider revising the narrative to one of limiting 401k plan leakage. Explain to plan participants, the benefits of maintaining their money in the plan. It’s true, most workplace exit interviews are oriented toward nudging employees to take their money when they leave their employer. That said, we as an industry need to do better when it comes to implementing and communicating smarter decumulation solutions — or ways to get money out of retirement plans. Based on the success of auto features in the accumulation phase — getting money into the plan via design features such as auto enrollment, contribution auto escalation, and default investments of target date funds – automation for decumulation is one idea that warrants consideration and conversation.
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