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Leaks are not just a problem for pipes.
Billions of dollars a year flow out of the U.S. retirement system as investors cash out their 401(k) plan accounts, potentially hurting their chances of having a sufficient nest egg.
The problem particularly affects job changers – especially those with small accounts – who often drain their accounts instead of rolling them over. They lose their savings and future income from that money.
According to the Employee Benefit Research Institute, about 40% of workers who leave their jobs cash out their 401(k) plans each year. According to the group’s most recent data, such “leaks” amounted to $92.4 billion in 2015.
Research suggests that much of this loss is due to “friction” – it’s easier for people to accept a check than to go through the multi-step process of transferring their money to their new 401(k) plan or an individual pension account is transferred.
The 401(k) ecosystem would have nearly $2 trillion more over 40 years if workers didn’t cash out their accounts, EBRI estimated.
But experts say recent legislation — Secure 2.0 — and partnerships between some of the country’s largest 401(k) administrators have helped reduce friction and plug existing leaks.
The movement “has really gained momentum in the last few years,” said Craig Copeland, EBRI director of wealth advantage research. “If you can keep it [the money] There, without any leaks, it will help more people have more money in retirement.”
85% of workers who cash out leave their 401(k) accounts depleted
US policy has many mechanisms to try to keep money in the tax-advantaged pension system.
Savers who withdraw money before the age of 59 usually have to pay a tax penalty of 10% in addition to income tax. There are also few ways for workers to access 401(k) savings before retirement, such as loans or emergency withdrawals, which are also technically sources of losses.
But changing jobs is another entry point that concerns policymakers: At that point, workers can, among other things, opt for a check (minus taxes and penalties).
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According to a U.S. Department of Labor analysis of Americans born between 1957 and 1964, the average baby boomer aged 18 to 56 changed jobs about 13 times. He held around half of the jobs before the age of 25.
A recent study found that 41.4% of workers cash out approximately 401(k) savings when they leave employment – and 85% of those people have exhausted their entire balance.
“Did they have to? “It is difficult to say for sure, but it is by no means a logical conclusion that a payout is a good or necessary response to leaving or losing a job,” authors John Lynch, Yanwen Wang and Muxin Zhai wrote about theirs Research in Harvard Business Review.
It’s not all the workers’ fault
However, not everything is the employees’ fault. By law, employers can cash out the small account balances of former employees who leave their 401(k) accounts behind. You can do this without the consent of the workers and send them a check.
Prior to 2001, employers could do this for accounts of $5,000 or less.
However, a law passed this year – the Economic Growth and Tax Relief Reconciliation Act – was among the first steps to keep more of those funds in the pension system.
If you can keep it [the money] There, without any leaks, it will help more people have more money in retirement.
Craig Copeland
Director of Asset Benefits Research at the Employee Benefit Research Institute
It prohibited employers from paying out amounts ranging from $1,000 to $5,000; Instead, companies that want to pull these funds out of their company 401(k) must roll the funds into an IRA on behalf of each employee. Secure 2.0 raised this cap to $7,000 starting in 2024.
While this IRA workaround saves more money in the retirement system, experts say it’s an imperfect solution. For example, upon rollover, assets are generally held in cash-like investments, such as money market funds, until investors elect to invest those assets elsewhere. There they earn relatively little interest, while the fees reduce the remaining balance.
Many investors also end up cashing out these IRAs, said Spencer Williams, founder of Retirement Clearinghouse, which manages such accounts.
Additionally, although employers notify their employees of such IRA transfers, employees who do not take immediate action may forget about their accounts entirely.
Why a new 401(k) “exchange mechanism” could help
In November 2023, six of the largest administrators of 401(k) plans – Alight Solutions, Empower, Fidelity Investments, Principal, TIAA and Vanguard Group – joined forces in an “auto-portability” initiative to further curb leakage.
Essentially, small balances — $7,000 or less — would automatically follow their owners to their new jobs unless they choose otherwise. This way, workers’ left-behind savings would not be paid out or rolled over to an IRA and potentially forgotten.
The concept uses the same hands-off approach as other now-popular 401(k) features like auto-enrollment, capitalizing on employees’ tendency toward inaction to their advantage.
Auto portability is essentially a “very large exchange mechanism” within the 401(k) industry, said Williams, who is also president and CEO of Portability Services Network, the company that facilitates these transactions. (Retirement Clearinghouse manages the infrastructure.)
One caveat: One of the six participating providers must manage the employee’s 401(k) plan at both their old and new employer for the transfer, meaning not all employees are covered. The companies collectively manage 401(k) accounts for more than 60 million people, about 63% of the market, Williams said. Others are invited to join the consortium.
With 70% market coverage, car portability is expected to reconnect about 3 million people annually to 401(k) accounts left behind when they changed jobs, Williams said. The biggest benefits would go to young workers, low-income earners, minorities and women, the groups most likely to cash out and have the fewest balances, he said.
It’s not just employees who benefit: Administrators keep more money in the 401(k) ecosystem, likely increasing their profits.
Experts said Secure 2.0 also gave a legal blessing to the auto portability concept, granting a “safe harbor” for automatic transfer of assets.
A “lost and found” 401(k) is in the works
Raja Islam | moment | Getty Images
That law also separately directed the U.S. Department of Labor to establish a “lost and found” office for old, forgotten retirement accounts by the end of 2024. The online public registry will help workers find plan benefits they may be owed and find out who they can contact to access them, according to a Labor Department spokesperson.
“Millions of dollars that people earn go unpaid every year because plans have lost track of the workers and their beneficiaries to whom they owe money,” the spokesman said. “This is a significant step forward in solving the problem.”
The Technology Modernization Fund, a government program, announced in November an investment of nearly $3.5 million along with the Department of Labor to help build the database.
Meanwhile, workers who suspect they have left an account behind have several options to reclaim it, the Labor spokesman said:
- Review old records, such as benefit statements or summary plan descriptions, to refresh your memory of benefits. You can also use an online search tool provided by the Department of Labor to find out whether your previous employer or union has a pension plan. Former employees may also be able to remind you of the company’s retirement plans or that the company has since been acquired or renamed.
- Contact former employers or unions to see if you received a retirement pension. Contacts may include a plan administrator, human resources, employee benefits, the owner of the business (if it is a small business), or a union.
- For assistance, contact Employee Benefits Security Administration counselors at askebsa.dol.gov or by calling 1-866-444-3272.
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2024-02-10 13:30:01
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