A leaking retirement account is a problem for the employee and will become a problem for the plan sponsor when the employees with leaking accounts can’t afford to retire.
So, how does a retirement plan leak? Through plan design features such as:
Loans that are not fully re-paid by termination of employment
Hardship withdrawals and their aftermath – the mandatory 6-month suspension of employee contributions
Age 59 ½ withdrawals
Choices made at termination of employment create leakage if the employee spends his account balance instead of preserving it for retirement.
Leaky plan design features are rooted in time when 401(k)’s and 403(b)’s were supplemental savings vehicles to defined benefit plans. Leakage was less of a concern when employees were earning a foundational level of monthly retirement income from defined benefit plans.
So, does a loan or hardship withdrawal here and there really have an impact on monthly retirement income? Absolutely! The Center for Retirement Research at Boston College predicts leakage can erode an employee’s final account balance at retirement by close to 20%*.
Leaking in itself is bad enough, but when the leak is from a bucket that is not nearly full enough, it can be devastating. If you are already not on track for a financially successful retirement, then you can’t afford for your half-empty bucket to leak.
So, what should you do if your retirement plan design includes leakage features? Change it!
Here are some options:
If your plan has an age 59 ½ withdrawal feature, take it out or raise the minimum age to 62 or older. Most of us will be working past age 65 anyway.
Change the permitted reasons for hardship withdrawal to a limited list – don’t just go with the expansive safe harbor list.
Make sure your plan includes an automatic re-start of contributions after the 6-month suspension period following a hardship withdrawal.
Ask your record keeper to accept loan payments from terminated employees either by issuing coupon books and/or accepting electronic payments from the employee’s bank or credit union. Some of the larger record keepers offer this service. The more plan sponsors who ask for it, the better the chance it will become a standard practice by record keepers.
Make it easy for terminated participants to leave their accounts in the plan at retirement. Expand the distribution options beyond the lump sum payment. Don’t forget to educate employees
Ask your record keeper to provide just-in-time messaging when the employee requests a leakage event – include an example of how leakage reduces retirement income.
Partner with your record keeper to provide education to all employees about the detrimental impact of loans and hardship withdrawals on retirement income. This can be as simple as a well-written snippet in a newsletter or a short video on the record keeper’s website – just create a catchy e-mail subject line and send the link to employees.
For years, plans sponsor have believed that they must allow employees access to their retirement funds prior to retirement in order to encourage participation in the plan, but it is possible to achieve desirable participation rates in 401(k) and 403(b) plans that do not allow for loans and hardship withdrawals.
It may take a few more years of educating plan sponsors (and employees) about their employees’ state of retirement readiness before leakage-blocking plan design changes are made, but it is certainly timely to begin deliberations and to educate employees regularly.
*Source: The Impact of Leakages from 401(k)s and IRAs ©, Alicia H. Munnell and Anthony Webb, The Center for Retirement Research at Boston College