Policy changes to reduce 401(k) plan ‘leakage’

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Leaks are not just a pipe problem.

When investors cash out their 401(k) plan accounts, billions of dollars a year are drained from the American retirement system, potentially reducing their chances of growing a substantial nest egg.

This problem largely affects job switchers – especially those with smaller accounts – who often close down their accounts rather than turn them around. They forfeit their savings and future earnings on that money.

About 40% of employees who leave their jobs withdraw money from their 401(k) plans each year, According To the Employee Benefits Research Institute. According to the group’s latest data, such “leakage” in 2015 amounted to $92.4 billion.

Research suggestion of Much of that loss is due to “friction” — it’s easier for people to take a check than to go through the multistep process of transferring their money to their new 401(k) plan or individual retirement account.

EBRI estimates that the 401(k) ecosystem would be worth about $2 trillion more over a 40-year period than if workers didn’t cash out their accounts.

However, experts said recent legislation – SECURE 2.0 – and partnerships between some of the nation’s largest 401(k) administrators have helped reduce friction and plug existing leaks.

“The movement has really gained momentum in the last few years,” said Craig Copeland, EBRI’s director of wealth benefits research. “If you can keep [the money] Without leaking it, this would help more people have more money in retirement.”

85% of workers who cash out deplete their 401(k)

US policy has several mechanisms to try to keep money in tax-preferred retirement systems.

For example, savers who withdraw money before age 59½ should generally do so Pay a 10% tax penalty in addition to any income tax due. There are also some ways for workers to access 401(k) savings before retirement, such as loans or hardship withdrawals, which are also technically sources of leakage.

But changing jobs is another access point, and one that worries policymakers: At that point, workers can opt out of the check (minus taxes and penalties), among other options.

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According to the U.S. Department of Labor, the average Baby Boomer changed jobs about 13 times between the ages of 18 and 56. Analysis Nearly half of Americans born between 1957 and 1964 held jobs before age 25.

One recent study found that 41.4% of workers withdraw some 401(k) savings upon termination – and 85% of those individuals depleted their entire balance.

“Did they need it? It’s hard to know for sure, but it’s by no means a logical conclusion that cashing out is a good or necessary response to quitting or losing a job,” Authors – John Lynch, Yanwen Wang and Muxin Zhai – wrote About his research in Harvard Business Review.

It’s not all the workers’ fault

if you can keep [the money] Without leaking it, this will help more people have more money when they retire.

Craig Copeland

Director of Wealth Benefits Research at the Employee Benefits Research Institute

it not to allow Allowing employers to withdraw $1,000 to $5,000; Instead, businesses that want balances from their company 401(k) must deposit the funds into an IRA in the respective workers’ names. SECURE 2.0 raised that cap to $7,000 starting in 2024.

While the IRA workaround keeps more money safe in the retirement system, experts said it’s an imperfect solution. For example, when a rollover is performed, the assets are typically held in a cash-like investment such as a money market fund until the investor decides to invest those assets differently. There, they earn relatively low interest while fees are deducted from the balance.

Many investors also eventually cash out those IRAs, said Spencer Williams, founder of the Retirement Clearinghouse, which manages such accounts.

Furthermore, although employers notify workers about such IRA rollovers, employees who do not take immediate action may forget about their accounts altogether.

Why the new 401(k) ‘exchange mechanism’ could help?

In November 2023, the six largest administrators of 401(k)-type plans – Elite Solutions, Empower, Fidelity Investments, Principal, TIAA and Vanguard Group – teamed up On “Auto Portability” initiative to stop leakage.

In basic terms, small balances – $7,000 or less – will automatically move their owners to their new job unless they choose otherwise. This way, workers’ remaining savings won’t be cashed out or rolled over to an IRA and potentially forgotten.

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This concept takes the same practical approach as other popular 401(k) features, such as automatic enrollment, taking advantage of workers’ tendency to be inactive in their favor.

Williams, who is also president and CEO of Portability Services Network, the entity that facilitates these transactions, said auto portability is essentially a “huge exchange mechanism” within the 401(k) industry. (The Retirement Clearinghouse manages the infrastructure.)

One caveat: One of the six participating providers must manage the worker’s 401(k) plan at both their old and new employers for a job transfer to occur, which means not all workers will be covered. Williams said the companies collectively manage 401(k)-type accounts for more than 60 million people, or about 63% of the market. More people have been invited to join the consortium.

Williams said that at 70% market coverage, auto portability is expected to reconnect about 3 million people per year with 401(k) accounts they left behind after changing jobs. The biggest benefits go to young workers, low-income earners, minorities and women, the groups most likely to withdraw cash and have the lowest balances, he said.

It’s not just workers who benefit: Administrators keep more money in the 401(k) ecosystem, potentially contributing to their profits.

Secure 2.0 also given legal blessings auto portability The concept, experts said, was to provide a “safe harbor” for the automated transfer of assets.

401(k) ‘Lost and Found’ is a work in progress

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That law also directed the U.S. Department of Labor to create a “lost and found” for old, forgotten retirement accounts by the end of 2024. The public online registry will help workers locate plan benefits they may be entitled to and identify whom to contact. According to a Labor Department spokesperson, them.

“Millions of dollars that people earn each year are not paid because the plans fail to track the workers and their beneficiaries who are owed money,” the spokesperson said. “This is an important step toward solving the problem.”

Technology Modernization Fund, a government program, in November announced An investment of approximately $3.5 million with the Department of Labor to help build the database.

In the meantime, according to a Labor spokesperson, workers who suspect they may have abandoned an account have a few options for reclaiming it:

  • Check old records such as statement of benefits or summary plan details to refresh your memories about benefits. You can also use the Department of Labor online search facility Check to see if your former employer or union has a retirement plan. Former coworkers may also be able to remind you about company retirement plans, or whether the company has been acquired or renamed.
  • Contact former employers or unions to ask if you earned retirement benefits. Contacts may include a plan administrator, human resources, employee benefits department, the company owner (if a small business) or a labor union.
  • Contact Employee Benefits Security Administration consultants for assistance Askebsa.dol.gov Or by calling 1-866-444-3272.

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