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A (Really) Surprising Reason for High Retirement Plan Leakage

DC Plan Design

The United States has the most liquid retirement savings system among developed countries, and participants take full advantage, a problem for long-term saving and accumulation, which is the system’s intended effect.

Surprisingly, researchers found that behavioral rather than economic factors account for high withdrawal rates at job separation, and the employer match might be to blame.

In a paper published late last year on the marketing-oriented research website Market Science, the authors noted that in a data set of 162,360 terminating employees covered by 28 retirement plans, “41.4% of employees leaked by cashing out 401(k) savings at job separation, [with] most draining their entire accounts.”

In a law of unintended consequences-like observation, they claimed that “the composition of funds in one’s 401(k) balance matters: leakage increases with employer contribution proportion.”

“Employers with more generous matches care about their employees’ well-being in retirement but unintentionally nudge employees to cash out when they change jobs,” they added.

The authors estimated that a 50% increase in employer/employee match rate increases leakage probability by 6.3% at job termination.

“However, there could be a 35.3% reduction in leakage probability if employees ignore the perceived incentive generated by the account composition effect. Approximately 60% of accumulated assets from a 50% increase in match rate leak out of the system due to the account composition effect attributable to the percentage of assets contributed by the employer.”

Auto Portability Advocates

With the Bureau of Labor Statistics estimating that the average worker will have 12.4 jobs in a career, the findings make a strong case for auto portability within the retirement plan system, something SECURE 2.0 addressed.

More specifically, it now permits a retirement plan service provider to automatically transfer a participant’s default IRA (established in connection with a distribution from a former employer’s plan) into the participant’s new employer’s retirement plan (unless the participant elects otherwise).

Also, under current law, an employer is permitted to distribute a participant’s account balance without participant consent if the balance is under $5,000, which will increase to $7,000 in 2024 under SECURE 2.0. 

And last fall, Retirement Clearinghouse announced the Portability Services Network, a consortium of major workplace retirement plan recordkeepers—Fidelity, Vanguard, TIAA, Empower, and Alight Solutions—dedicated to seamless auto-portability.

“A joint venture is a great way to think about it,” Retirement Clearinghouse President and CEO Spencer Williams said. “It’s an independent entity that acts as a utility. The nature of any utility is to benefit its people without a profit motive of its own.”

Williams explained that the network’s scale (40%-plus market share at inception) means it can reasonably project volume and predict when it will hit various benchmarks to reduce participant costs.

“If you think about it from a record keeper’s perspective, Fidelity, Alight, and Vanguard can and are taking auto-portability out to their customer base,” he concluded. “Since the announcement, we’ve concentrated on filling board seats. Vanguard is finishing its technology implementation, and Fidelity will be done by June 30. We expect to have the beginnings of reportable activity by the end of the year.”