"Particularly during the economic downturn, employers and financial advisors have been increasingly vocal about the negative impact that cashing out of a 401(k) plan has on retirement savings," explains Pamela Hess, Hewitt’s director of retirement research. "But employees don’t seem to be getting the message. In a society where less than one in five workers will likely be able to meet their needs in retirement, employers and policymakers need to work together to implement solutions that change employee behaviors and reduce cash-out rates. Otherwise, millions of Americans who rely on defined contribution plans will find themselves unable to achieve a financially secure retirement."
Younger Workers More Apt to Cash Out
Hewitt’s study shows that younger workers are more likely to cash out their 401(k) account than those who are older and more tenured. Six in ten (60 percent) employees in their 20s took a cash distribution compared to just one-third (34 percent) of those in their 50s.
"The high cash-out rate among young and middle-aged workers is troublesome because these employees are missing out on the opportunity for decades-worth of tax-deferred growth on their investments. Over the course of 20 or 30 years, modest amounts of savings can turn into surprisingly large sums of money," says Hess.
For example, an employee who cashes out $5,000 from his or her retirement plan at age 25 may potentially be sacrificing $75,000 at retirement, yet he or she only receives a small amount - perhaps only $3,500 - from the cash out due to taxes and penalties.
Account Balance Heavily Influences Cash Out Rate
Hewitt’s analysis also found a direct correlation between 401(k) plan balances and cash-out rates. Just 8 percent of workers with plan balances of $100,000 or more cashed out, and less than one in five workers (17 percent) with plan balances between $20,000 and $99,999 did so.
Conversely, the number of cash outs among employees with smaller balances is much higher. Almost half (45 percent) of workers with balances between $1,000 and $5,000 took a cash distribution. Eighty-five percent of those with balances under $1,000 cashed out either voluntarily or due to force-out provisions.
Recommendations to Decrease Cash Outs
Hewitt offers four ways policymakers and employers can discourage workers from cashing out their 401(k) balances:
- Limit access to retirement monies at termination. Regulators could enact legislation that would delay workers’ ability to cash out their 401(k) until age 59 ½. Until that age, employees would either be able to leave their savings in their prior plan, or roll over their money into another 401(k) plan or into an IRA.
- Educate and communicate with workers about the negative effects of taking a cash distribution. Participant web sites should promote information about the long-term consequences of cashing out a 401(k) plan. For example, employers could provide terminated workers with modeling tools that project their account balance under different scenarios: leaving their assets in their prior 401(k) plan, rolling over their assets into an IRA or cashing out in the form of a lump-sum distribution.
- Offer more institutional funds. According to Hewitt’s analysis, nearly 60 percent of assets from terminated employees remained in 401(k) plans when the majority of investment options offered were institutional funds (non-mutual funds). And because these funds often afford tiered pricing - where as assets grow, fees continue to decline - they allow workers to retain more of their assets over time and build a bigger nest egg.
- Simplify the rollover process. Instead of the long, paper-intensive procedure that’s currently in place, companies could adopt a web-based, paperless rollover process. Doing so would eliminate much of the confusion and frustration many employees feel when trying to roll over their assets into another qualified plan or into an IRA.
