401(k) or ATM? Automated Retirement Savings Prove Easy to Pluck Prematurely (#GotBitcoin?)
Researchers find that workers withdraw nearly half of their enforced contributions within eight years. 401(k) or ATM? Automated Retirement Savings Prove Easy to Pluck Prematurely
Some workers are finding it hard to ignore the money they’re supposed to be setting aside for their golden years.
The retirement savings made possible for millions of Americans thanks to automatic enrollment in 401(k)-style plans is proving to be an alluring pool of money for workers to borrow from or cash out when they leave a job.
The findings, from academic economists known for their work on retirement-savings plans, answer a question that has long concerned employers that put workers into 401(k) plans and give them the option to drop out, rather than requiring them to sign up on their own: Will auto-enrolled workers treat their 401(k)s like automated-teller machines?
The answer, according to the study, is yes—but not to the extent that the workers spend all their gains from auto-enrollment. Within eight years of joining a 401(k) plan, the results indicate that automatically enrolled workers withdraw nearly half of the extra they manage to save, compared with workers left to sign up for the retirement plan on their own.
The findings illustrate how difficult it can be to change savings and spending habits. And this tapping or pocketing of retirement funds early, a phenomenon known in the industry as leakage, threatens to reduce the wealth in U.S. retirement accounts by about 25% when the lost annual savings are compounded over 30 years, according to a separate analysis by economists at Boston College’s Center for Retirement Research.
Thanks to auto-enrollment, “we have figured out how to get money into the retirement savings system,” said Brigitte Madrian, a co-author of the new study and an economist at Harvard University. “Now we need to think about how to keep that money in the system.”
Within 401(k) plans, auto-enrollment has boosted average participation rates above 85%, compared with 63% for plans without the feature, according to 401(k) recordkeeper Alight Solutions LLC. But by sweeping employees into 401(k) plans at default savings rates that typically hover near 3%, automatic enrollment also initially creates lots of accounts with relatively small balances.
After leaving a company, just over 60% of 401(k) participants with balances below $10,000 liquidate their accounts—paying income taxes and often a 10% penalty—rather than leaving the money or transferring it to another tax-advantaged retirement plan, according to Retirement Clearinghouse LLC.
“When people hardly have any money in the system, it doesn’t seem worth it to them to roll it over,” said Lori Lucas, president of the nonprofit Employee Benefit Research Institute.
Workers who don’t switch companies fall prey to a separate temptation: 401(k) loans.
With more money in the plan, Prof. Madrian said, auto-enrolled employees are more likely to borrow from their 401(k) accounts over time than are workers who are required to sign up for the plan on their own. While most 401(k) borrowers repay themselves with interest, about 10% default on about $5 billion a year, according to Olivia Mitchell, an economist at the University of Pennsylvania’s Wharton School.
The upshot, Prof. Madrian said, is that while “balances under auto-enrollment are higher, they are not as high as they could be.”
Because automatic enrollment is fast becoming the norm, the findings are likely to attract the attention of policy makers and industry professionals. Currently, 68% of large employers have adopted auto-enrollment, up from 58% in 2015 and 34% in 2007, according to Alight.
The study looked at the savings and leakage levels for 7,347 employees a large financial-services company hired in the 12 months before July 1, 2005, when it adopted automatic enrollment. The authors compared data for those employees to 7,536 employees the company hired in the 12 months immediately after it started using auto-enrollment.
After applying the same investment returns to both groups, the study found that eight years after hire, the employees who were auto-enrolled had an average of about $1,200 more—in 2004 dollars—in their 401(k) accounts than the workers hired a year earlier who were left to sign up on their own. (The $1,200 average includes savings of both employees who left the firm before the eight years elapsed and those who stayed.)
The big reason why auto-enrollment boosted savings: It raised the firm’s 401(k) participation rate from 62% to 98%, converting many who would have contributed nothing into savers, said Prof. Madrian.
‘When people hardly have any money in the system, it doesn’t seem worth it to them to roll it over. ’
—Lori Lucas, president of the Employee Benefit Research Institute
But the auto-enrolled employees also withdrew an average of about $850 more from their 401(k)s than the employees who had to voluntarily enroll, reducing their potential gains from auto enrollment by 42%.
More than half of the auto-enrolled participants—59%—cashed-out their savings, largely driven by employees who left the company. In contrast, among the employees who joined the 401(k) voluntarily, the figure was 43%. One reason for the higher cash-out rate: While more of the auto enrolled workers saved, a greater share of their balances fell below $1,000, a level at which companies are allowed to issue checks to departing workers, many of whom cash them, said Prof. Madrian.
Among the 15% who remained at the firm for eight years, 31.5% of the auto-enrolled employees had 401(k) loans outstanding, versus 26.3% for the voluntarily enrolled group. Defaults, which never exceeded 12% of employees’ total outstanding loan balances, were similar for both groups.
Prof. Madrian says the study should provoke “discussion about what’s causing leakage and what we can do about it.”
To reduce cashouts, many retirement policy experts recommend automating the process of transferring money from an old employer’s plan to a new employer’s plan; currently, departing employees who don’t want to leave money behind in a previous employer’s 401(k) plan can roll it over tax-free into an individual retirement account or a new employer’s plan, but they have to fill out paperwork. Some also favor doing away with a rule that allows companies to issue checks to departing employees with 401(k) balances below $1,000, many of whom cash the checks rather than deposit them in IRAs.
The findings may also fuel greater use of workplace wellness programs. These typically combine financial education with customized advice, delivered by apps and human advisers, to help employees develop basic money-management skills.
Currently, 17% of large companies offer financial-wellness programs that incorporate online tools and 42% offer one-on-one consultations, up from 9.2% and 35.7%, respectively, in 2015, according to investment-consulting firm Callan LLC.
Kaneka North America LLC, a subsidiary of a Japanese producer of chemicals, plastics and medical devices, plans in September to start offering its 400 U.S.-based employees the option to contribute—via after-tax payroll deductions—to an emergency savings account linked to its 401(k) plan.
“We think the emergency savings accounts will help people who are used to using the 401(k) plan like a bank account,” said Alvin L. Proctor, vice president of human resources. Mr. Proctor says the company hopes to see the percentage of employees taking loans decline to 6% from 13% annually.
Phil Waldeck, president of Prudential Retirement, which is Kaneka’s 401(k) provider, says employees must currently voluntarily enroll in the emergency savings portion of the plan. But if a bill recently introduced in Congress passes, it will allow employers to automatically enroll workers into such accounts.
Labor Department Clears Path for Automatic 401(k) Transfers
Recent actions pave the way for automatic transfers of 401(k) balances of $5000 or less.
Companies could start automatically transferring small retirement accounts belonging to employees who change jobs to the 401(k) plans of their new employers, according to new guidance from regulators.
The move is the latest effort to reduce the premature flow of money out of 401(k)-style plans. A pair of recent Labor Department actions would give Retirement Clearinghouse LLC of Charlotte, N.C. a green light to automatically transfer small balances of $5000 or less to a new employer’s 401(k) plan, provided the employee doesn’t opt out. For balances above $5000, the employee’s permission is generally required before money is transferred. The Labor Department may ultimately give other companies permission to enter the market, provided they agree to the conditions it set for Retirement Clearinghouse.
Such automatic transfers have the potential to sharply reduce the millions of employees who raid their 401(k)s when they switch jobs, the biggest source of what the industry calls leakage, analysts said.
“You’re talking about potentially billions of dollars staying in the retirement system that would otherwise be lost,” said Aron Szapiro, director of policy research at Morningstar, Inc.
In a news release, the Labor Department cited the possibility that such automatic transfers would “eliminate duplicative fees for small retirement savings accounts and reduce leakage of retirement savings from the tax-deferred retirement savings system.”
It is unclear whether employers and companies that serve as 401(k) record-keepers will adopt the new service on a widespread basis, industry participants said. For example, because of privacy concerns, some may balk at the prospect of sharing information about 401(k) savers with the company facilitating the transfers.
On average, about 30% of people leaving jobs elect to cash out their 401(k) accounts and pay taxes—and often penalties—rather than leave the money or transfer it to another tax-advantaged retirement plan, according to industry research. As many as 80% of people leaving jobs with less than $5,000 in their accounts eventually cash out.
Tapping retirement funds early threatens to reduce the wealth in U.S. retirement accounts by about 25% when the lost annual savings are compounded over 30 years, according to an analysis by economists at Boston College’s Center for Retirement Research.
Under current law, employers can mail a check to former employees with balances of $1000 or less, making it easier for employees to cash out their accounts. For those with balances between $1000 and $5000, employers must either transfer those funds to an individual retirement account or keep them in the plan, unless the employee directs otherwise.
Because of Labor Department regulations, the IRAs are generally invested in either a money market or certificate of deposit, which offer low returns. Some participants even lose track of such accounts.
Mark Iwry, who oversaw retirement policy in the U.S. Treasury Department during the Clinton and Obama administrations, said automatic transfers “should be a major step forward in reducing leakage.”
Retirement Clearinghouse Chief Executive Spencer Williams said his company requested the Labor Department advisory opinion because plan sponsors and 401(k) record-keepers wanted greater clarity about who has fiduciary liability for the service. The Labor Department clarified that Retirement Clearninghouse is the fiduciary for the transaction, he said.
Separate guidance from the agency would shield the firm from a provision of the Employee Retirement Income Security Act of 1974 prohibiting fiduciaries from self-dealing, including earning fees as a result of their recommendations. The Labor Department has asked the public to submit comments before it completes the proposed exemption.
The company plans to charge a maximum one-time fee of $59 for each transfer. For accounts with $590 or less, the charge will be 10% of the balance, and the service is free for accounts with $50 or less, said Mr. Williams.
Retirement Clearinghouse, which has been developing the service for years, is building a system to share data on 401(k) participants with record-keepers to find a departing employee’s new plan and facilitate the transfer. One client is currently using the system, said Mr. Williams, who predicts volume will increase over the next year.
Currently, almost 15 million Americans with 401(k) accounts change jobs annually, said Mr. Williams. One-third, or about 5 million, have balances of $5000 or less, and roughly 80% of those people cash out their accounts within seven years of leaving a job, he said.
Automatically transferring all these small 401(k) accounts would save participants an additional $1.5 trillion, in 2017 dollars, over 40 years, according to the nonprofit Employee Benefit Research Institute. Currently, 401(k)-style accounts hold almost $8 trillion, according to the Investment Company Institute, a trade group for mutual funds.
Some analysts said automatic transfers are likely to appeal to 401(k) record-keepers, many of whom are eager to get rid of small accounts that can cost more to administer than they earn in revenues.
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