Too many 401(k) plans have sprung a leak.

That’s the verdict of a new paper issued by the Center for Retirement Research (CRR) on “plan leakage,” defined as “any type of pre-retirement withdrawal that permanently removes money from retirement savings accounts.” It calls for plan sponsors to emphasize the importance of 401(k)s as do-not-touch savings vehicles, despite employees’ many pressing financial needs.

There are plenty of leaky IRAs out there too, according to the study, “The Impact of Leakages on 401(k)/IRA Assets.”

The problem is particularly troublesome, according to authors Alicia Munnell and Anthony Webb, given the fact that so few employees are on track to have set enough to be able to afford to retire. “The typical working household [in 2013] with a 401(k) approaching retirement had only $111,000 in [retirement] assets,” according to the report.

Leakage can occur in three ways:

  • In-service withdrawals,
  • Cash-outs at job change, and
  • Loans.

In-service withdrawals, of course, can be “hardship” ones require to meet an “immediate and heavy financial need,” including medical care, postsecondary education, and buying, repairing or avoiding foreclosure on a house. Hardship withdrawals are taxable, and subject to a 10% penalty tax. That cost does not deter many plan participants, however.
Other in-service withdrawals are those by employees who have reached the 59-1/2 year old threshold for the 10% penalty.  CRR estimates that about 30% of such withdrawals represent leakage, with the balance being rolled over into IRAs.

How big is the problem? CRR, based on analyzing data from Vanguard, reports that about 4% of participants in plans that allow for in-service withdrawals in 2013 did so. Total withdrawals amounted to one percent of plan assets. Seventy percent of that amount is for purposes other than those defined as “hardship” conditions.

Here’s a recap of “leakage” amounts for Vanguard’s clients, as a percent of plan assets, in 2013:

  • Cashouts: 0.5%
  • Hardship withdrawals: 0.3%
  • Post-59-1/2 distributions: 0.2%
  • Loan defaults: 0.2%

CRR believes Vanguard plans are better than average when it comes to leakage, so these numbers represent the lower end of the range.
Here’s how typical leakage rates would impact a hypothetical 60-year-old, assuming the individual began making contributing to a plan at age 30 at an average rate of 6% of pay with a 60% employer match and a moderate 4.5% annual rate of return. With no leakage, that person would have accumulated $272,000, but that amount would be reduced by one-fourth, to $203,000, according to the CRR estimates.

CRR offers no magic bullets for employers to plug the leaks. However, when plan sponsors are aware of the impact of seemingly small pre-retirement withdrawals, they can convey that to participants to encourage them to think twice before taking out those funds.

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