LAST REVIEWED Dec 08 2021 7 MIN READ
Cashout leakage occurs when participants voluntarily withdraw tax-qualified retirement savings following a job change before retirement age
These early withdrawals often result in participants having to pay taxes and penalties
Auto-portability could help participants automatically and seamlessly transition accounts between employers
While 401(k)s provide tax advantages over the long term, many workers are tempted to withdraw their retirement savings every time they leave or change jobs. Participants who take early distributions (defined by most retirement plans as withdrawals made before age 59 ½) suffer from “cashout leakage,” in which they lose the unrealized gains they would have accrued by keeping their savings intact until retirement age.
More than 30% of all participants and up to 50% of minority workers will cash out their retirement when they change jobs, with gig, part-time, and other nontraditional workers disproportionately impacted. In fact, the average person will change jobs seven to 11 times during their career, providing that many opportunities to cash out prematurely. Historically, savings lost to cashout leakage amounts to approximately $100 billion annually, but this number could rise dramatically with the Great Resignation and overall labor volatility.
Ultimately, participants who liquidate their 401(k) often may find out too late that cashout leakage can make the difference between a comfortable retirement—or no retirement at all.
The government’s response to cashout leakage
In recent years, retirement providers, companies, and even the federal government have begun addressing pitfalls of the retirement system that lead to many Americans not having enough money for retirement. One solution both the private and public sector have explored is auto-portability, in which savings can automatically and seamlessly be transitioned from one employer to the next—or to an individual retirement account (IRA)—to reduce cashout leakage.
Portable Retirement and Investment Account (PRIA) Act of 2021
In September 2021, Congressman Jim Himes (D-CT) and Senator Mark Warner (D-VA) introduced the Portable Retirement and Investment Account (PRIA) Act of 2021. This legislation would give everyone in the United States a single account to which they could contribute when they lack access to a qualified plan. As with traditional retirement plans, workers could choose their investments and employers could also contribute to PRIAs. Unlike traditional plans, however, employees would still be able to make contributions even after separation. This ability to maintain saving momentum would likely provide the incentive participants need to maintain their funds when facing a change in employment status.
The PRIA Act is set to be referred to the Ways and Means Committee in the House and the Finance Committee in the Senate.
U.S. Senate’s Special Committee on Aging
Even more recently, the U.S. Senate’s Special Committee on Aging, “A Financially Secure Future: Building a Stronger Retirement System for All Americans,” presented its findings on the role of auto-portability in solving challenges to the retirement system. During the hearing, J. Spencer Williams, CEO of Retirement Clearinghouse, testified about the company’s work with the U.S. Department of Labor (DOL) to create regulatory guidance that would better facilitate auto-portability.
Williams founded Retirement Clearinghouse in 2001 to help boost retirement savings among minorities. In 2018, the DOL issued guidance on auto-portability and offered a safe harbor for retirement providers seeking to provide seamless transfer of savings, naming Retirement Clearinghouse as a fiduciary. The company has become the leading proponent of retirement portability and the DOL’s designated fiduciary for retirement providers working to implement auto-portability.
Retirement Clearinghouse is now working with Vanguard and Alight Solutions to bring auto-portability to more than 16 million savers. Williams testified that passing legislation aligned with the DOL’s guidance and providing tax incentives to providers would most likely increase adoption of auto-portability by retirement providers.
“Auto-portability is simple, a technology that allows a person’s account to automatically follow them from one employer to the next,” Williams testified. “The idea is that if we keep it easy and automatic, more people will keep their savings in a plan rather than cashing out.”
The Employee Benefit Research Institute estimates auto-portability can preserve $1.5 trillion in additional savings over the coming generation. Of that amount, more than $190 billion would be saved by black workers. In his testimony, Williams pointed out that $10,000 appears to be the inflection point at which participants start to view their balances as worth keeping for the long haul. He emphasized the importance of helping workers incubate retirement accounts at least until they get to that amount.
What are the implications of auto-portability for plan administrators and investment advisors?
With only one company offering the supporting technology and the cost associated with lack of competition, it’s likely that only the largest retirement companies will be able to offer auto-portability in the near term. It remains to be seen how the government will expand its response to the growing call for auto-portability and what incentives it will provide.
Even if you can’t yet incorporate automatic transfer of savings into your retirement plan, you can help participants maintain their balances when their employment status changes by offering guidance and education that underscores the importance of keeping savings in place until retirement age. This can include anything from specific instructions for rolling over 401(k) accounts, to providing calculators to quantify not just withdrawal and penalties, but also the projected loss of compound interest.
Ultimately, cashout leakage is a problem for everyone, but it hits minority participants hardest. With the burden of convincing employees not to cash out falling largely on the plan sponsor’s shoulders, partnering with a 401(k) provider with robust education resources—including guides for specific challenges that cause employees to empty their savings—can go a long way toward safeguarding workers’ retirement plans, specifically for the more financially vulnerable.
The Human Interest Team
We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment education, and integration with leading payroll providers.