Two-fifths (41 per cent) of U.S. employees are cashing out their 401(k) plan savings when they leave a job, with 85 per cent draining their entire accounts, according to a new report by the University of British Columbia, Texas State University and the University of Colorado Boulder.
The report, which analyzed data from more than 162,000 employees covered by 28 retirement plans, found cashing out increased with the proportion of the 401(k) balance contributed by employers and it’s most likely driven by behavioural explanations rather than economic.
When a departing employee taps into 401(k) savings prior to the age of 55, they have to pay a 10 per cent penalty in addition to income taxes, but the data showed this penalty hasn’t been a strong deterrent.
Three-quarters (75 per cent) of the plans include auto-enrolment, with default contribution rates between one and eight per cent. Nearly half of these plans also have auto-escalation programs that allow the plan sponsor to raise participants’ default contribution rates by one per cent every year until the escalated contribution rate reaches the target, which varies from five to 25 per cent.
When leaving their jobs, 59 per cent of employees said their 401(k) balances stayed within the retirement system, 35 per cent were withdrawn as a total cash-out and six per cent were a partial cash-out.
The report also found multiple withdrawals were inconsistent with opportunistic planned leakage. Employees with multiple withdrawals took an average of 8.5 months to deplete their accounts. Conditional on leakage, 64 per cent of employees took a one-time total cash-out after job termination. Among the remaining 36 per cent who initially requested a partial cash-out, 58 per cent eventually withdrew every penny in their retirement account.
“The way the plans are administered makes taking a cheque the path of least resistance for many employees,” said the report’s authors in a press release. “There is more bureaucratic paperwork to roll savings over into an independent retirement savings account or their next employer’s retirement savings program. If departing employees now think of that cheque as a windfall rather than hard-earned retirement security when the employer contributed more, [they’re] less likely to endure the hassle to dutifully roll that money over.”