By Thomas Hawkins | October 12, 2020
In the 1960’s, counter-culture guru Timothy Leary urged a generation to “turn on, tune in and drop out.” It’s probably a good thing that I didn’t take his advice….at least not the “drop out” part!
If Leary were still around and sponsoring a 401(k) plan, he might urge participants to “save up, move on and cash out.” While that sounds contradictory and profoundly ill-advised, cashing out is exactly what 5 million job-changing 401(k) participants do in the first year following separation.
Thankfully, Leary’s not advising 401(k) participants, but it begs a question. What causes so many 401(k) participants – individuals who’ve previously behaved responsibly enough to participate, to save and to diversify – to suddenly squander their tax-qualified savings after they change jobs? More importantly, what can plan sponsors do about it?
The real answers may surprise you.
What Really Causes 401(k) Participants to Cash Out?
For one-third of job-changing 401(k) participants who cash out, there’s a simple answer: they’re facing a true financial emergency.
For the remaining two-thirds who’ll cash out unnecessarily, my stock answer used to be that “cashing out is easy – moving your retirement savings forward is hard.” Facing friction and succumbing to the temptation of sudden money, these job-changing participants had limited options, made extremely poor, hasty decisions and elected to cash out in droves – or so the argument used to go.
While that explanation has been historically accurate, viable solutions now exist to the cashout problem.
Moving forward, the REAL reason that unnecessary cashout leakage persists will be 401(k) plan sponsors who’ve not chosen to make seamless plan-to-plan portability a priority.
Winning Battles, Losing the War
Getting 401(k) participants to act in their own long-term self-interest has always been an interesting behavioral challenge. While human beings uniquely possess the ability to think ahead and to plan, most of us are poorly skilled in the long-term planning and decision-making required to effectively save for retirement.
Motivating new employees to participate, to save and to diversify has long been a vexing problem for our voluntary 401(k) system. To encourage these virtuous behaviors, innovative 401(k) plan features emerged, promoting the goals of participation (auto enrollment), saving (auto deferral, auto escalation) and diversification (target date funds). With these features, participants are required to opt out of good behavior, not opt in.
With key behavioral battles won on the front-end, our 401(k) system inexplicably loses the war on the back-end, when these same participants separate and plan features promoting responsible behavior suddenly go AWOL.
What 401(k) Plan Sponsors Can Do
The final weapon required to win the war on unnecessary cashouts and to preserve participants’ retirement savings is true plan-to-plan portability.
When job-changing participants are educated to understand their options and, most critically – are actively assisted in moving their retirement savings forward – research conclusively demonstrates that cashout leakage can be reduced by at least 50%, across the entire spectrum of account balances.
Generally, portability features come in two flavors:
- For separated participants with balances less than $5,000 who are subject to their plan’s automatic rollover provisions, auto portability delivers default, plan-to-plan portability. Similar to other “automatic” plan features, participants must actively choose to opt out of the good behaviors of retention and consolidation that auto portability promotes, not opt in.
- For separated participants with larger balances where consent is required, providing participants with access to “managed portability” that includes expert assistance will dramatically reduce cashouts.
Embrace Existing Portability Plan Features
If plan sponsors choose to fully embrace these already-existing 401(k) portability features, job-changing 401(k) participants will no longer have to “face friction and make bad decisions” nor will they behave as if Timothy Leary were their advisor.