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How to Plug Leaking DC Plans

Plan leakage is a major roadblock to achieving broad retirement readiness, with 45% of DC participants cashing out their plan balances upon leaving their job, according to one report. There are many reasons why participants cash out, notes Warren Cormier of Boston Research Technologies, and some clear solutions that could mitigate the problem.

Writing in the most recent issue of NAPA Net the Magazine, Cormier writes that cashing out a plan balance “is neither a natural proclivity nor a cultural norm,” yet it persists nonetheless. Cormier says that it’s not just the suddenly unemployed who cash out their balances, but many workers who quit voluntarily to take new positions. And they do so knowing full well that there is a significant cost to that action, in the form of penalty fees.

According to a study conducted by his firm, many of those who took a payout said they did so because it was simply easier to get a check than it was to figure out how to roll their balance into their new employer’s account. Of those who cashed out, 80% said they were fully aware of the taxes and penalties associated with doing so.

Changing Viewpoints

Cormier writes that stopping plan leakage requires a mindset change, where employees stop viewing retirement savings as “bonus” money that they can turn into an immediate windfall, and instead look at it as the retirement nest egg that grows much larger if left undisturbed. He suggests that plan sponsors need to better frame the consequences of cashing out, not by listing the immediate costs to the participant’s balance, but by showing how much money they are leaving on the table at age 65 by taking a lump sum now.

Making it Simple

In addition, Cormier says that the roll-in process for transferring balances between employers needs to be simplified, and employers need to stop automatically cashing out plans on behalf of their exiting workers. Cormier says that a large number of employees view the roll-in process as being both time-consuming and confusing, and yet another laborious task coming at the same time that they have to acclimate themselves to a new job, or even worse, suddenly not having a job at all.

Role of Financial Education

The Boston Research Technologies study Cormier cites also shows that cash outs occur nearly equally across income levels (35% of those making under $35,000 and 33% of those earning over $150,000 cash out), but there is a wide disparity between those with “very low financial wellness” (46% cash out) and “very high financial wellness” (just 16% do). Thus, Cormier says, stopping plan leakage will also require larger-scale financial education for all plan participants.

Related: The Face of Friction

In addition to Cormier’s regular “Inside the Plan Participant’s Mind” column, the Summer issue of NAPA Net the Magazine highlights what the new generation of plan advisors are thinking — including the 2015 NAPA “Young Guns” list — along with a recap of this year’s NAPA 401(k) Summit in San Diego, and the cover story, which examines five key factors that advisors should look at when determining whether longevity-planning options are right for their clients. The Summer issue also features regular contributors Nevin Adams, Steff Chalk, David Levine, Brian Graff, Don Trone, Fred Barstein, Jerry Bramlett and NAPA President Joe DeNoyior — and marks the debut of a new column on financial wellness by Jania Stout.

To view Cormier’s column, click here and select “Stopping Cash-Outs: New Behavioral Insights.” And to view a pdf of the full 48-page issue, click here.