While lawmakers are quick to tout initiatives aimed at
boosting retirement plans, none of the bills in Congress proposes shutting down
retirement plan “leakage.” Leakage — how people drain assets from their defined
contribution retirement plans through borrowing, early withdrawals and
cash-outs — is costing investors dearly, according to studies and surveys of
John C. Bogle, founder of the Vanguard Group index mutual
funds, said that under the defined contribution model in use today, early
withdrawals are granted too easily, loan qualifications are not strict enough
and repayment terms are too lenient. No doubt, once investors interrupt putting
money away for tomorrow, it’s even more difficult for them to restart their
Loans are particularly costly. Within five years of taking a
loan from their 401(k), 40 percent of borrowers decreased their savings rate
and more than one-third of those who took a loan stopped saving altogether, a
recent Fidelity Investments survey found.
Financial advisors generally don’t encourage borrowing
against savings, although there may be times when a 401(k) home loan is an
option. Loans against retirement accounts rose in the wake of the 2008
financial crisis, particularly among workers earning between $40,000 and
$60,000 annually, according to a 2011 survey by Aon Hewitt on how loans,
withdrawals and cash-outs erode retirement savings.
The Aon Hewitt survey also found that withdrawals rose in
the wake of the financial crisis. In 2010, 6.9 percent of defined contribution
plan participants took a withdrawal, and 20 percent of the withdrawals were
related to hardship, with an average amount of $5,510, the survey found. The
remaining 80 percent were withdrawals by investors who were eligible to take
out the funds since they had reached the required age of 59.5 years. The average
withdrawal amount for those investors was $15,480, the survey found.
Cash-outs, the “take the money and run” equivalent when an
employee leaves an employer plan through termination or early retirement, are
the most “injurious” forms of leakage, according to the Aon Hewitt survey.
Among workers who terminated employment in 2010, 42 percent
took a cash distribution, the survey found. Retirement plan participants who
cash out benefits can expect to see their retirement income reduced from 11
percent to 67 percent, Aon Hewitt said. Cash-outs cost retirees dearly because
of taxes and penalties.
With "outs" like these, critics of the nation’s
defined contribution system aren’t surprised that so many working Americans are
falling short of their retirement goals.
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