In a new report, the Congressional Joint Committee on Taxation estimates that 22% of net contributions to 401(k) and other workplace retirement savings plans made by people age 50 or younger during a given year are withdrawn early in the form of hardship withdrawals, loans or cash withdrawals by persons changing jobs.
According to the report, pre-retirement withdrawals from retirement accounts are often referred to as “leakages”,Estimated Leakage from Retirement Savings Accounts.”
The Joint Committee says the most common reason for flight is quitting a job, but it can also be caused by five life events, the most common of which is becoming unemployed or experiencing a negative income shock, followed by a house purchase, a divorce or a separation. , a large medical expense or new tuition fees.
However, pension plan advisors and sponsors can take steps to prevent leaks, including starting with educating participants, according to executives at the Retirement Clearinghouse (RCH), which offers automatic 401(k) transfer services. to Individual Retirement Accounts (IRAs). ) or new 401(k) plans. They also say a plan can hire a company such as RCH to guide new hires and outgoing employees during turnovers.
The first thing advisers and sponsors need to do to prevent pension leaks is to tackle loans and withdrawals in times of difficulty, says Neal Ringquist, executive vice president and chief sales officer at RCH.
“When it comes to in-service withdrawals, it’s a delicate balance that sponsors have to make,” says Ringquist. “Restrict on-the-job withdrawals too much and plan membership suffers” because plan members don’t want to give up access to their money, he says. “Make it too liberal and the leaks increase.”
He says middle ground advisers should recommend that sponsors authorize only one loan at a time.
Another way to prevent leaks is to help employees set up emergency savings accounts.
Those with a savings account dedicated to emergencies were half as likely to dip into retirement funds during the pandemic, according to a report by the Commonwealth and the Defined Contribution Institutional Investment Association (DCIIA) Center for Retirement Research. . The study found that low-to-moderate income respondents with less than $2,000 in liquid savings were twice as likely to have taken out a 401(k) loan or hardship withdrawal in response to the COVID-19.
“Emergency savings play a vital role for those who have them,” says Catherine Wright, chief innovation officer at Commonwealth. “The pandemic has really demonstrated how essential these savings are. I imagine that in the future we will see more and more professionals offering emergency savings through the employer channel. »
When it comes to cash drains, communication about the importance and benefits of consolidating retirement assets is always helpful, especially in the active plan, adds Ringquist. “In that sense, the advisor can ensure that the plan accepts rollover contributions from pension plans and IRAs — and offer services to help facilitate those rollovers into the plan.”
Thomas Hawkins, senior vice president of marketing and research at RCH, says he’s not at all surprised by the findings of the Joint Committee on Taxation that the main reason for leaks is cash withdrawals when people change jobs.
“It’s important to understand the problem first,” says Hawkins. “The cash leaks that occur after the separation [from a job] is by far the biggest leak problem, accounting for 89% of all leaks,” he says, quoting 2009 data of the General Accountability Office (GAO).
Boston Research Technologies also published a study that found that two-thirds of money leaks are preventable and not used for a real emergency, he continues.
RCH found that “two-thirds of participants who cash out have balances below $5,000,” Hawkins adds. He also says the best way to prevent leaks is to educate participants, both for newly separated participants and for new hires. In fact, Hawkins argues that education can reduce money outflows by more than 50%.
However, an analysis of tax data by Investment Company Institute (ICI) economists Peter Brady and Steven Bass argued that some studies significantly overestimate retirement account leakage. This could be because different studies use different definitions of ‘leakage’. ICI economists, for example, define “leakage” as early withdrawals from retirement accounts used for purposes other than retirement.
But no matter how many leaks a plan sees, Spencer Williams, president and CEO of Retirement Clearinghouse, says advisers need to make sure plan members receive training. “An advisor should ensure the plan has engaged a service provider that specializes in providing counseling and education to new hires and firing employees to help them make good decisions and prevent leaks,” says -he.