The problem of “leakage” isn’t as gross as it sounds, but is nonetheless incredibly damaging—especially for 401(k)s.
Research firm Cerulli Associates finds cash-outs and loan defaults are responsible for more than $80 billion in lost 401(k) and similar assets in 2014.
“Premature distributions, cash-outs of retirement accounts, and defaults on loans are major sources of DC asset leakage and were responsible for outflows of nearly $80 billion in 2014,” Cerulli research analyst Shaan Duggal said in a statement. “Limiting these leaks is of the utmost importance to participants and the retirement industry.”
The report, Evolution of the Retirement Investor 2015: Insights into Investor Segmentation and the Retirement Income Landscape, examines retirement decisions made by individual investors throughout their retirement planning lifecycle, with particular emphasis on 401(k) plan participants, IRAs and rollovers, and retirement income.
“Part of the problem is that outside of the interaction with their record keeper or IRA service provider, there is really nothing stopping anyone from accessing either a terminated DC or IRA account early,” Duggal explained. “Nearly every Gen-Xer who completed a cash distribution from their 401(k) ended up paying an additional 10% penalty on top of regular taxes to the IRS. When a distribution is requested, record keepers should spring into action, conveying the benefits of preserving the tax-deferred nature of the assets.
“Loans are also a source of 401(k) leakage, albeit smaller, but when they are defaulted on immediately they cause a taxed and penalized event for the already cash-strapped individual,” she concluded. “Removing the entire loan function from the plan may be extreme, but restricting the amount of outstanding loans to only one will slowly do away with the idea that the DC plan is meant to be a source of short-term liquidity.”
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.
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