Lock it up and leave it alone. That’s the core advice from a new issue brief and working paper by Alicia Munnell and Anthony Webb of the Center for Retirement Research at Boston College, addressing the serious issues caused by 401(k) withdrawal. They highlight that such withdrawals, which they refer to as “leakages,” are responsible for reducing overall 401(k)/IRA retirement wealth by about 25 percent.
The authors report that as of 2013, the typical working household with a 401(k) approaching retirement had only $111,000 in 401(k)/IRA assets. One reason for the relatively low balances, the claim, is that individuals can tap their nest eggs during their work lives, resulting in “leakages” that erode assets at retirement. The brief, titled “The Impact of Leakages on 401(k)/IRA Assets,” summarizes a recent study and focuses on the size of leakages, their impact on retirement wealth, and options for reducing them.
“Leakages are any type of pre-retirement withdrawal that permanently removes money from retirement saving accounts,” they write. “Over the past few decades, the potential for leakages has greatly increased due to two developments: 1) the shift from defined benefit plans to 401(k) plans; and 2) the movement of retirement assets from 401(k)s to IRAs.”
It is this second point, rollovers from 401(k)s to IRAs, that can be particularly problematic.
“The shift to IRAs moves savings to a different environment, one with a lower standard of regulatory oversight that is potentially more susceptible to leakages,” Munnell and Webb explain. “For example, as discussed below, 401(k) withdrawals before age 59½ can be made only due to hardship or job change. IRA withdrawals can be made any time and without justification.”
Moreover, they add, compared to IRAs, 401(k) hardship withdrawals pose more of an administrative burden for participants. And 401(k) withdrawals are subject to 20 percent withholding for income taxes, while IRAs are not.
“Finally, certain types of hardship withdrawals are exempt from penalty; and IRAs have more such exemptions than 401(k)s.”
Citing an earlier report from Vanguard titled “How America Saves 2014,” the authors report that in
2013 about 4 percent of participants in plans offering in-service withdrawals used this feature and 1 percent of total assets were withdrawn. Additionally, about 0.5 percent of total assets were cashed out and 401(k) loan provisions accounted for a nominal 0.2 percent of assets.
They provide an example that finds that, under their assumptions, leakages result in accumulated 401(k) wealth of $203,000 at age 60 compared to $272,000 with no leakages; which results in the aforementioned reduction of 25% in their account balance.
“A recent paper explored the optimal degree of illiquidity in the retirement saving system and concluded that, on balance, household financial well-being would be improved if penalties for accessing funds before retirement were much higher than under current policy,” they conclude. “In other words, the primary goal should be to keep monies in the plan for retirement. Thus, while many experts have proposed piecemeal ways to reduce leakages, it may be time to address leakages more comprehensively.”
See Also:
- Why 401(k) ‘Cashout Leakage’ is a Crisis
- Recordkeeper Data Show 401k Defined Contribution Dedication
- 3.3% Safe Withdrawal Rate is the New 4%: Morningstar
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
