The first rule of retirement income hasn’t changed: Taking money from a qualified account before retirement—through cashouts, loan defaults, or hardship withdrawals—is almost always a costly mistake. Leakage from 401(k) plans may reduce wealth at age 60 by as much as 25 percent, while leakage from IRAs reduces it by 23 percent.
Yet, Americans continue to use their retirement savings for non-retirement purposes.
The 2016 T. Rowe Price Parents, Kids & Money Survey reported that during the past two years, forty-four percent ofhave used retirement savings to pay for non-emergencies, such as reducing debt (17 percent), vacations (17 percent), children’s education (16 percent), holiday spending (15 percent), day-to-day expenses (13 percent), home down payments (9 percent), childcare (8 percent), and weddings (8 percent).
Cashouts are the biggest culprit, according to the Employee Benefit Research Institute (EBRI). Employees change jobs about every three years. Plan participant data cited by EBRI shows that almost two-thirds of participants’ cash-out retirement savings, knowing they’ll owe penalties and taxes, because it’s the easiest course of action.
Younger Americans are particularly susceptible to this error in judgment. Studies have found that Millennials are more prone to spending retirement savings than older generations, which may reflect their youth and distance from retirement. When queried about the savings they currently have in qualified accounts, 20 percent of Millennials indicated they would spend the money before retirement.
Many plan sponsors and the advisors with whom they work address issues associated with leakage through retirement education and plan design changes. Improving financial literacy through retirement education is key, particularly when so much advice is available to participants and not all of it is sound. For instance, a 2015 online article offered this advice to its readers, “You shouldn’t always wait until you retire to pull money from your retirement account.”
The author went on to offer the opinion that, since Millennials’ retirements would be vastly different from those of earlier generations, spending retirement assets on education, career advancement, or other expenses that would help them live happily today was an acceptable choice.4
Many experts argue that it is not.
The need to preserve assets is one of the ideas that must be communicated to working Americans of all ages through retirement education. Focusing attention on evolving retirement planning issues may help. For instance,
Current plan participants are likely to have fewer sources of retirement income than current retirees do. Traditional defined benefit (DB) pension plans are rapidly becoming extinct. Earlier this year, Willis Towers Watson reported that the number of Fortune 500 companies offering traditional DB plans to new hires had fallen from about 50% in 1998 to 5 percent in 2015.
While that may be beneficial for many employers, it makes generating enough income to live comfortably in retirement far more challenging for employees. A survey from the Insured Retirement Institute (IRI) shows that it won’t be easy to replace pension income, which comprises about one-half of retirement income for 40 percent of current retirees.
IRI estimates suggest that a retired couple without pension income would need to save $485,000 to generate $25,000 annually from an immediate, life-only annuity. Most of today’s retirees don’t have enough money saved to afford such an annuity and maintain liquid assets to recover other types of expenses.
Returns on investments may be lower in the future, according to a recent report from The McKinsey Global Institute. In the United States, real returns for equities averaged 7.9 percent between 1985 and 2014, and real returns for bonds averaged 5 percent. During the next 20 years, McKinsey expects,
“In a slow-growth scenario, total real returns from US equities over the next 20 years could average 4 to 5 percent…Fixed-income real returns could be around 0 to 1 percent…Even in a higher-growth scenario based on resurgent productivity growth, we find that returns may fall below the average of the past 30 years, by 140 to 240 basis points for equities and 300 to 400 basis points for fixed income.”
Lower future return estimates could have a profound impact on retirement plans.
Longevity is increasing rapidly, and so is longevity risk. If participants’ life expectancies exceed those assumed in planning models, then they may outlive their savings. It’s a significant risk. In fact, between rising life expectancies and higher medical costs, it may not be possible to save too much for retirement. The Economist explained:
“Over the past 50 years, every forecast of how long people will live has fallen short…life expectancy in rich countries has grown steadily, by about 2.5 years a decade, or 15 minutes every hour…That is good news for health-care providers, cruise companies and (on the whole) humanity. It is most unwelcome for those paying the bills to finance this extended lease on life.”
EBRI estimates the national retirement savings shortfall in the United States is, “…$4.13 trillion for all U.S. households where the head of the household is between 25 and 64, inclusive.” Helping reduce plan leakage by providing greater clarity around planning assumptions—sources of income, estimated returns, and longevity risk—is a step in the right direction.
Terry Dunne is Senior Vice President and Managing Director of Rollover Solutions Group at Millennium Trust Company, LLC. Mr. Dunne has over 35 years of extensive consulting experience in the financial services industry. Millennium Trust Company, LLC acts as a directed custodian, and does not provide tax, legal, or investment advice.
 Akbas, Merv et al. ‘Plan leakage: A study on the psychology behind leakage of retirement plan assets.’ Defined Contribution Institutional Investment Association. February 2016.
 Jackson, Nancy Mann. ‘Is it ever a good idea to tap into your 401(k) early?’ CNBC. February 25, 2015.
 McFarland, Brendan. ‘A Continuing Shift in Retirement Offerings in the Fortune 500.’ Willis Towers Watson. February 18, 2016.
 Insured Retirement Institute. ‘It’s All About Income: Inaugural Study on the American Retirement Experience.’ September 2016. Pages 7-8.
 Dobbs, Richard, et al. Diminishing Returns: Why Investors May Need To Lower Their Expectations. McKinsey Global Institute. May 2016. P. viii.
 VanDerhei, Jack. ‘Retirement Savings Shortfalls: Evidence from EBRI’s Retirement Security Projection Model®.’ EBRI Issue Brief, No. 410. February 2015.