By Tom Hawkins
Cashout leakage, a long-standing problem in America’s defined contribution system, is a silent crisis that unnecessarily robs millions of Americans of a comfortable, timely or secure retirement. Plagued by misunderstanding and neglect, it’s vitally important to understand the problem and to take decisive action to curb it.
The fourth of a five-part series, this article addresses policies with the most promise to reduce the 401(k) cashout leakage problem.
Plugging Cashout Leakage: The Range of Policy Options
Cashout leakage has multiple causes, so it makes sense to consider a range of policy options to address the problem. In this article, I’ll examine three broad categories of potential solutions – each representing fundamentally unique approaches – which I’ll evaluate and render my personal verdict on their overall efficacy.
1. Eliminating or Restricting Early Withdrawals
A sure-fire solution to cashout leakage is to eliminate participant choice by prohibiting pre-retirement 401(k) withdrawals altogether. Similarly, options to restrict early withdrawals could include increasing penalties, extending the penalty age (ex. from 59-1/2 to 62), etc.
High-profile proponents of restrictions, including academic Theresa Ghilarducci
and 401(k) guru Ted Benna
, argue that our 401(k) system is fundamentally flawed in allowing these early withdrawals to occur at all.
Advocates of choice focus on the voluntary nature of the 401(k) – where incentives and disincentives influence participants’ actions, but there is no compulsion to participate, or to remain. They further argue that erecting barriers to exit would have a chilling effect on participation and deferral rates.
- Eliminates or greatly reduces cashout leakage.
- Potential for highly-negative second-order effects, including lower participation and deferral rates.
- Practicality of delivering a policy solution. Would require significant legislation but has little political or industry support.
Verdict: Potentially effective, but fatally flawed.
2. Addressing Financial Emergencies
A 2015 survey of America’s mobile workforce
found that approximately one-third of cashout leakage is due to a true financial emergency. These findings are further supported by multiple studies indicating an emergency-savings crisis for Americans, with about 7 in 10 having less than $1,000 in liquid savings. With so many lacking the capacity to handle a financial emergency, the level of cashout leakage attributed to financial emergencies makes perfect sense.
A promising solution comes in the form of emergency-savings plans, helping participants avoid financial crises by encouraging rainy-day savings. Established alongside 401(k) plans, these “sidecar” accounts would accumulate savings up to a targeted level.
In their simplest form, the plans could be established on a “DIY” basis by employers, accumulating after-tax savings. Alternatively, they could be more-closely integrated in the 401(k) system and ERISA, as envisioned by the SECURE Act of 2018, which provided for auto-enrollment in employer-sponsored emergency savings accounts.
- Addresses a fundamental cause of cashout leakage.
- Research suggests high need, high adoption rates by employers and employees.
- Positive second-order effects; could even promote greater 401(k) participation rates.
- Requires enabling legislation, if attached to 401(k) accounts.
Verdict: Very promising and fundamentally sound.
3. Facilitating Portability
Even well-intentioned job-changing participants quickly learn that it’s very difficult to consolidate retirement savings, particularly for smaller balances. Thus, many cash out after concluding that it’s simply not worth their time. Conversely, it’s very easy to cash out, so the prospect of “sudden money” can be very tempting to some, even if it’s not in their long-term best interests.
Facilitating portability evens the scales for job-changers by making portability easy – and in the case of small balances – an automatic default.
The research on portability’s benefits is extensive and uniformly supportive:
- A 2013 study by Boston Research Technologies examined a program of portability at a 250,000+ participant plan. Portability came in the form of consolidation assistance for terminated participants, and through the facilitation of roll-ins for new participants. The study concluded that the program was highly-effective in stemming cashout leakage, resulting in a 51% decrease in cashouts, vs. prior experience, and a 52% decrease vs. industry averages.
- For small balances subject to automatic rollover provisions, the widespread adoption of auto portability could preserve $1.5 trillion in savings over a generation, according to research by the Employee Benefit Research Institute (EBRI).
Perhaps the best news is that the Department of Labor, through Advisory Opinion 2019-01A
and Transaction Exemption 2019-02
, has established the guidance required for widespread adoption of auto portability, which now depends upon the priorities of plan sponsors and recordkeepers.
- Extensive research confirms portability’s benefits, to the entire retirement system, as well as specific demographic segments.
- By consolidating accounts, portability could significantly reduce the incidence of missing participants by reducing the number of accounts most prone to go missing.
- No additional legislation or regulatory guidance is required.
- Positive second-order effects, including strong alignment with initiatives that expand access to workplace retirement savings accounts.
- Pace of adoption depends upon the priorities of plan sponsors and recordkeepers.
Verdict: Necessary and vitally important – literally savings trillions.
The Way Forward
If our 401(k) system is to remain voluntary and retain participant choice, some levels of cashout leakage will always exist.
The good news is that cashout leakage can be greatly reduced through policies that facilitate portability and address emergency savings. Even better news is that the one solution with the greatest potential impact – auto portability – is now ready for widespread adoption.