Live Market News

Policy changes look to reduce 401(k) plan ‘leakage’

Latest Market News
1 of 85

Sturti | E+ | Getty Images

Leaks aren’t just a problem for pipes.

Billions of dollars a year drip from the U.S. retirement system when investors cash out their 401(k) plan accounts, potentially crippling their odds of growing an adequate nest egg.

The issue largely affects job switchers — especially those with small accounts — who often drain their accounts instead of rolling them over. They forfeit their savings and future earnings on that money.

About 40% of workers who leave a job cash out their 401(k) plans each year, according to the Employee Benefit Research Institute. Such “leakages” amounted to $92.4 billion in 2015, according to the group’s most recent data.

2024 Tax Tips: New 401(k) limits

Research suggests much of that loss is attributable to “friction” — it’s easier for people to take a check than go through the multistep process of moving their money to their new 401(k) plan or an individual retirement account.

The 401(k) ecosystem would have almost $2 trillion more over a 40-year period if workers didn’t cash out their accounts, EBRI estimated.

However, recent legislation — Secure 2.0 — and partnerships among some of the nation’s largest 401(k) administrators have coalesced to help reduce friction and plug existing leaks, experts said.

The movement “has really gained momentum in the last few years,” said Craig Copeland, EBRI’s director of wealth benefits research. “If you can keep [the money] there without it leaking, it will help more people have more money when they retire.”

85% of workers who cash out drain their 401(k)

U.S. policy has many mechanisms to try to keep money in the tax-preferred retirement system.

For example, savers who withdraw money before age 59½ must generally pay a 10% tax penalty in addition to any income tax. There are also few ways for workers to access 401(k) savings before retirement, such as loans or hardship withdrawals, which are also technically sources of leakage.

But job change is another access point, and one that concerns policymakers: At that point, workers can opt for a check (minus tax and penalties), among other options.

More from Personal Finance:
How to save for retirement in your 50s
What to know about aging in place in retirement
States try to close retirement savings gap

The average baby boomer changed jobs about 13 times from ages 18 to 56, according to a U.S. Labor Department analysis of Americans born from 1957 to 1964. About half of the jobs were held before age 25.

One recent study found that 41.4% of employees cash out some 401(k) savings upon job termination — and 85% of those individuals drained their entire balance.

“Did they need to? It’s hard to know for sure, but it is by no means a logical conclusion that cashing out is a good or necessary response to leaving or losing a job,” the authors — John Lynch, Yanwen Wang and Muxin Zhai — wrote of their research in Harvard Business Review.

It’s not all workers’ fault

Read More: Policy changes look to reduce 401(k) plan ‘leakage’

Leave a comment

This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Accept Read More

Get more stuff like this
in your inbox

Subscribe to our mailing list and get interesting stuff and updates to your email inbox.

Thank you for subscribing.

Something went wrong.