2 October 2022

Plugging the Retirement Savings Drain

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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 retirement plans.

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 savings habit.

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.

Click here to access the full article on InsuranceNewsNet.

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