By Spencer Williams
Knowledge is power, as the saying goes. As Americans observe another Financial Literacy Month, members of the retirement services industry have an opportunity to pause and think about how they can help empower more people to achieve a financially secure retirement.
Plan sponsors and recordkeepers, in particular, have an opportunity to educate more participants, via their financial wellness programs, with tips and insights to improve their retirement outcomes. One of the best tactics for saving more for retirement is to avoid prematurely cashing out 401(k) accounts after changing jobs. But unfortunately, too many American workers view cashing out to be the least expensive and time-consuming option, due to the historic lack of seamless plan-to-plan asset portability infrastructure in the U.S. retirement system.
According to the Employee Benefit Research Institute (EBRI), our country’s retirement system loses about $92 billion in savings every year due to the premature withdrawal of retirement plan assets upon job-change. The plan participants prematurely cashing out their retirement savings accounts are typically paying taxes and penalties on those early withdrawals.
Financial Literacy Month offers a chance for plan sponsors and recordkeepers to educate participants about why retirement account cash-outs are so detrimental to their retirement readiness.
A study undertaken by the Center for Retirement Research at Boston College found that, on average, premature cash-outs reduce participants’ income in retirement by 25%. In addition, industry research from Retirement Clearinghouse, LLC demonstrates that a hypothetical 30-year-old plan participant who cashes out a 401(k) account with less than $5,000 today would forfeit up to $52,000 in savings the balance would have accrued by age 65, assuming the account would have grown by 7% per annum.
Sadly, many participants—including those in our society who are already financially at-risk—do not understand the extent of the damage premature cash-outs can reap on their savings for retirement. EBRI estimates that 14.8 million plan participants with a retirement account switch jobs each year—and nearly one-third (31%) of them will prematurely cash out their accounts within one year of arriving at their new employers, according to data from the largest retirement plan recordkeepers. However, minorities and low-earning workers are far more likely to cash out than the average participant. While 31% of all plan participants prematurely cash out within a year of job-change, 63% of Black Americans and 57% of Latinos do so, and 50% of participants earning $20,000 to $30,000 in annual income do so.
Through their financial wellness programs, plan sponsors and recordkeepers can inform participants about the dangers of prematurely cashing out, as well as educate them about auto portability, which can enable them to transport and consolidate their accounts instead.
Auto portability is the routine, standardized, and automated movement of an employee’s retirement savings account with less than $5,000 from their former employer’s plan into an active account in their current employer’s plan. EBRI estimates that, if adopted across the U.S. over the course of a 40-year period, auto portability would preserve an extra $1.5 trillion in savings (measured in today’s dollars) in our country’s retirement system. This would include $191 billion for 21 million Black Americans, and $619 billion for all minority plan participants.
This outcome would go a long way toward closing the longstanding wealth gap for minorities, by empowering these communities to increase the savings they can enjoy in retirement.
During the present Financial Literacy Month, take the opportunity to review your financial wellness initiatives for plan participants, and redouble your efforts to give them the tools and programs they need to save more for retirement, such adding an auto portability service.