If you think of retirement savings as a key part of a healthy retirement, then anyone who has prematurely cashed out 401(k) savings during their working life has suffered a compound fracture that will require several stages of therapy to fully rehabilitate. But a cash-out isn’t the only impediment to a financially secure retirement for these hardworking Americans.
According to Bank of America Merrill Lynch’s “2017 Workplace Benefits Report,” 79% of employees experienced an increase in healthcare costs last year, leading 63% of women and 62% of men to decrease their retirement-savings contributions.
With rising healthcare costs undermining many Americans’ financial wellness, eradicating cash-out leakage and preserving savings by eliminating friction within the U.S. retirement system — the root cause of cash-out leakage — are more important than ever for helping Americans save as much for retirement as possible.
Participants who consistently roll their 401(k) savings into their current-employer plans as they change jobs demonstrate good saving habits that lay the groundwork for lifetime participation in the U.S. retirement system. These participants have the highest probability of achieving a healthy and financially secure retirement.
When a participant chooses not to consolidate their savings into their current-employer plan, their retirement savings suffer a severe injury that puts their hard-earned dollars at risk and reduces their chances for a healthy retirement. The injury can take many forms, including a complete loss of their savings as a result of cashing out, the payment of taxes and penalties that reduces the amount of money that they actually receive upon cashing out, and worst of all, the loss of future compounded earnings on those savings. Even when a participant chooses to preserve their savings in a former employer’s plan or an IRA, they will end up paying unnecessary, duplicative fees for multiple accounts over a period that could span several decades.
Let’s start by examining the least-bad scenario. A hypothetical 30-year-old worker who preserves their savings, but does so by stranding their $5,000 of savings in a previous-employer plan today, would have to pay $2,052 in fees on that account over the next 35 years. On a compounded basis, that $2,052 translates to $8,488 in lost savings by age 65, assuming the account balance increases in value by 7% annually.
Moving on to the worst-case scenario, cashing out, the participant creates a much more severe fracture. If the same hypothetical 30-year-old cashes out their $5,000 401(k) savings account balance today, they would wind up losing more than $52,000 in compounded savings by age 65, assuming the account balance increases in value by 7% annually. And in addition to paying early withdrawal fees up-front which reduce the balance they receive at the time of the cash-out, the hypothetical 30-year-old would have to pay taxes on the amount they cashed out — causing them to lose even more savings they could have enjoyed in retirement.
Despite the brutal damage that a cash-out inflicts on retirement savings, research shows that many participants choose to cash out because it is the easiest option available to them when changing jobs. The complex, costly and time-consuming nature of DIY plan-to-plan portability makes cashing out appear more attractive to a lot of participants than completing a roll-over which would consolidate their 401(k) savings into their current-employer plans. This unhealthy habit was confirmed by Boston Research Technologies’ 2015 study of the mobile workforce, which found that, among participants who cashed out within a year of changing jobs, 63% cashed out for non-emergency purposes.
Millions of American workers have already experienced retirement-savings fractures and never fully recovered. Worse, if their unhealthy habits don’t change, millions more will suffer their first fracture, or an additional fracture, via cash-outs this year, and millions more will do so every year thereafter. The Employee Benefit Research Institute estimates that approximately 22% of our country’s 66.2 million defined contribution plan participants change jobs annually. Research from the largest plan record-keepers indicates that 31% of those 14.8 million job-changers, or 4.6 million plan participants, will cash out within the first year of switching employers.
These participants aren’t just losing billions of dollars in aggregate savings when they cash out. Rising healthcare costs will cause many of them to reduce their 401(k) contributions, thereby making it even more difficult for them to “catch up” and heal the fractures in their retirement savings. This triple whammy — taxes and penalties plus lost compounded savings resulting from cash-outs, additional fees paid on stranded accounts, and reduced contributions due to rising healthcare costs — is undermining much of the positive impact that “automatic” programs such as auto-enrollment have had on Americans’ capability to save enough for retirement.
Help plan participants save, preserve as much as possible for retirement
Plan sponsors and record-keepers can help participants mend their fractured savings by both actively encouraging them to consolidate their 401(k) savings in their current-employer plans, and facilitating the consolidation. This support for participants is consistent with their fiduciary duty, and can be offered as part of any financial wellness program, along with counseling about 1.) how participants who have suffered retirement-savings fractures can make up what they’ve lost, and 2.) how participants can cope with rising healthcare costs without harming their prospects for achieving a financially secure retirement.
Sponsors and record-keepers can also take the necessary steps to make plan-to-plan portability a less expensive, complicated and time-consuming process. Specifically, they can participate in a nationwide clearinghouse whose role is to facilitate auto-portability, the routine, standardized and automated movement of a plan participant’s 401(k) savings account from their former employer’s plan to an active account in their current employer’s plan.
By automating the process of rolling 401(k) savings account balances over to an account in a current-employer plan at the point of job-change, auto-portability holds the key to reducing, and possibly eradicating, cash-out leakage. And because the roll-in transaction is a common feature in 401(k) plan design, adoption by plan sponsors will align smoothly with existing practices. According to research from the Plan Sponsor Council of America, 97.2% of defined contribution plan sponsors are already capable of accepting roll-ins from other plans.
According to EBRI, under a scenario in which auto-portability is widely adopted, up to $2 trillion in retirement savings, measured in today’s dollars, could be preserved for hardworking Americans in the retirement system. With rising healthcare costs causing many workers to contribute less to their 401(k) savings accounts, preserving $2 trillion in the nation’s retirement system would give these workers a huge boost toward healing the fractures in their retirement savings — and achieving a healthy retirement.
Spencer Williams is President and CEO of Retirement Clearinghouse, a portability solutions provider.
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