Cash Leaking Out of 401(k) Plans at Alarming Rate

A quarter of money socked away for retirement comes out early, much of it subject to penalties and income taxes. For many, the venerable 401(k) is just too darned inefficient

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The persistent problem of savers pulling money from their 401(k) plan has grown worse since the financial crisis, heightening concerns about the effectiveness of these plans as a retirement tool.

One in four American workers with a 401(k) or other defined contribution plan tap their retirement account for current expenses, a new study shows. This “leakage” reached $70 billion in 2010, equal to nearly a quarter of all contributions that year.

(MORE: Young Workers with a 401(k) Finally Get Diversified)

Looking only at workers’ contributions (excluding employer matching funds), individuals are spending 40% of the money they put away for retirement, reports online financial firm HelloWallet. Among other findings:

  • Penalized 401(k) withdrawals increased from $36 billion to almost $60 billion from 2004 to 2010.
  • Workers in their 40s are most likely to breach their savings for nonretirement needs.
  • 75% of those who cash-out their entire balance do so because of basic money-management problems.

(MORE: How to Dump Your Fee-Filled 401(k))

Money leaks out of 401(k) plans before retirement in three basic ways: hardship withdrawals, loans that do not get repaid and cash-outs when workers switch jobs. All these have the effect of greatly reducing workers’ retirement security. Thirty years ago, most workers had a guaranteed pension at retirement; today, the $3.5 trillion in self-directed 401(k) and other defined-contribution plans is the primary retirement account of most Americans.

The issue is so concerning that experts are looking for reasonable alternatives to 401(k) plans. Some believe funds borrowed from a 401(k) should be insured. Workers who borrow from their plan and then lose their job must repay the loan. If they cannot, the loan is in default and treated as a distribution. This not only opens the worker to penalties, it permanently reduces their retirement account. Insurance would guarantee that a laid-off worker with such a loan would not lose their nest egg.

Fidelity found in 2010 that a record 22% of 401(k)-plan participants had a loan outstanding and that the default rate on those loans was skyrocketing. Defaults on 401(k) loans account for up to $37 billion of leakage annually, according to a study from Robert Litan at Brookings and Hal Singer at Navigant Economics.

(MORE: It’s Back, not a Moment Too Soon: The 401(k) Match)

The good news is that outstanding 401(k) loans have hit a plateau (though at a high level) as the economy has bottomed and begun to turn up, according to the Employee Benefit Research Institute. Some groups — those under age 25 and over 60 — are doing an especially good job of avoiding these loans. Most loans get repaid but those that do not remain a nagging source of money leaking from the retirement kitty.

Cash-outs are an even bigger source of leakage. Participants who take out money before age 59 and half rather than roll it into another qualified plan, are subject to a 10% penalty and immediate income tax.

All this raises even more questions about 401(k) plans, which in many ways have failed Americans as a primary retirement-savings vehicle. If so much money earmarked for retirement is going to be pulled out early, 401(k) plans would seem to be a terribly inefficient tool. The high costs of leakage point up the value of building and maintaining an emergency fund even before building a nest egg.

MORE: It’s Peak Season for Shopping Because You’re Depressed

117 comments
lMikeG
lMikeG

...until there is a union of all employees to combat the mighty companies, there will be no victory for the citizens of the country. Imagine if every employee in the country was a part of a union and one day that union declared a strike... Although the companies now control the terms of employment and, for the most part, the money, they can't operate entirely without employees. Only in that case would we really have the power to negotiate the terms of our lives and work- the government can't and won't, but they can't force us to go to work...

Entitled
Entitled

am tired of self-righteous neo cons saying that people who are on hard times are morally lacking and irresponsible. I agree that people should manage their 401ks better. In fact, a person who starts making regular contributions to a 401k in their 20s will be much better off than a person with a pension come retirement age, as long as they stay the course. However, most of us are battered by economic forces that are beyond our control. When faced with a choice between 401 distribution or starvation what choice does one have?

It is easy to say that they should have done this or that they should have done that, however they are in the situation that they are in and coulda, woulda, shoulda is a waste of time. We routinely bail out corporations who act irresponsibly so why not help people? 

NotEntitled
NotEntitled

Dear Dan Kadlec:

You claim that 401(k) plans have failed and that alternatives need to be considered.  Your justification for this claim is that more people are withdrawing their money earlier than expected.  But your best point was the last sentence, which contradicts your premise and your conclusion:  "The high costs of leakage point up the value of building and maintaining an emergency fund even before building a nest egg."

In other words, what ever happened to personal responsibility?  

401(k) plans were founded on the notion that people should take responsibility to at least share in funding their retirement.  A 401(k) plan is a tool that encourages workers to save some of their earnings for their future.  Participants are given tax breaks and often matching employer dollars if they do contribute.  Low income workers are even given a tax CREDIT (like a match from the government) for contributing (google it: "low-income 401(k) savers tax credit").  So far, in the past 30+ years, participants have contributed trillions, and only a small minority have withdrawn signficant amounts earlier than upon retirement.

What would be the alternative to 401(k) plans and personal responsibility?  Continue to have employers fund defined benefit plans?  So when the economy takes a turn for the worse, the employers would either curtail their benefit funding or lay off workers or go belly up?  And we know the PBGC can't handle any more DB defaults, because they are already ~$100 billion underfunded, with taxpayers ultimately on the hook for that.  So much for insuring retirement accounts.

Or would you rather have the government guarantee retirement funds for everyone?  Oh, wait, that's called Social Security, and that's also on the way to the Graveyard of Good Intentions.

Or you want insurance for participant loans??  Really?!  Who will pay the premiums for that insurance?  I am surprised that Time magazine, which has made clear it wants provider fees to be lowered in the 401(k) market, would want to add another layer of cost and another profit center for insurance companies.  

Again, I think the answer here is personal responsibility.  If the participant doesn't want to be left holding his loan bag, maybe he should manage his personal finances and create an emergency fund before he gets into that situation.  

And let's not demonize the plan sponsors or providers for the "leakage" issue.  The plan sponsor (employer) doesn't have to allow loans or in-service distributions or hardship withdrawals.  These are features that are optional and can be put in the plan document.  Nobody is forcing these options on anyone.  Most employers allow these options because they do two things:  (#1) They give participants the freedom of having another option if they get themselves into hot water, and (#2) the ability to pull money OUT encourages people to put money IN.  Participation and contribution rates have INCREASED because of the option to take a loan or in-service distribution or hardship withdrawal.  But, again, the premise is that people will be responsible enough to make good decisions, knowing that there are consequences if they do not.  Kind of like what America was founded on.

By the way, in the HelloWallet study that you cited, does it explain how they got to the 40% leakage statistic?  Did they consider that many people are using their 401(k) savings early only because they had put so much into it with the idea that they'd be able to tap it if the economy went in the toilet?  Perhaps the 401(k) plans are doing exactly what they were intended to do?

Next time you write an article on a topic like this, don't just take some statistics and jump to conclusions.  Talk to some actual practitioners in the industry first.  Otherwise, we might follow your logic and end up creating insurance for ignorance and stupidity.  Maybe that's the "reasonable solution":  Let's create a government-backed insurance program that insures everyone against the unfortunate tragedy of personal irresponsibility.  Oh, wait, no, that's communism.

TracyCapp
TracyCapp

BACK IN THE 50'S-60'S  1/3RD POPULATION HAD UNION JOBS..  REMEMBER THE WAY IT WAS?

A MAN HAD 1 JOB "A HOUSE AND 2CARS IN EVERY GARAGE"  AND HIS WIFE STAYED AT HOME TO

RAISE THE KIDS.....NOW  5% POPULATION HAS UNION JOB, MOM WORKS,DAD HAS 2 JOBS..

REPBUBLICANS TOOK IT ALL AWAY..NOW IT IS ALL ABOUT MAXIMUM PROFITS OVER EVERYTHING ELSE..

WILL CREATE DOWNWARD SPIRAL OF RAISING PRICES THAT LESS AND LESS PEOPLE CAN AFFORD...=

LESS FROFIT, SO RAISE PRICES, PAY PEOPLE LESS ..OVER AND OVER =WE ALL WILL SUFFER GUARANTEED!!

seasons2216
seasons2216

In the early 80's my father made what was considered a half way decent wage. You know that that was? 40,000 a year. It's not rocket science to do the math to figure out how stagnant wages have been. A middle class home also sold for 70- 80,000 at this time. Rent for a 3 bedroom house was $700.00 and gas prices were much lower, so were utility bills and food. 

We have had democratic leaders and republican leaders since then. 

We have given companies tax break after tax break to hire and they are still getting these tax breaks. - The last tax break they were offered was based on how many people the hired and kept on. One of the biggest retailers in the nation "jumped in on this tax break". Does anyone know or remember what happened with them? They ended up paying the government back because they couldn't hire  and keep enough employees. The tax breaks and the "trickle down" effect has not worked and is not working.

Our government is still giving out tax breaks for shipping jobs over- seas. 

Maybe there are a lot of young people out here that have no clue yet what they have to look forward to, maybe there are older people out here who are getting their Social Security and or pension, but there are people who worked long and hard that are in the forties who have lost everything, and not because they over- bought a home, because they lost a good paying job, had to cash in their retirement to make the bills they had and to take care of their families. They have taken jobs making half of what they once made. 

During the census a lady came to my door to survey us. She told me she had been laid off and then her husband. She also said  the census job was temporary and was going to end soon. She said she had no idea what they would do after that. 

I met another woman who was wearing big diamonds and nice clothes. She said she worked for a company for twenty- six years and they let her go to hire someone younger that they could pay less. This woman had to be in her fifties, at least. She said she was lucky her husband had a good job.

It is not always mismanaged money!! 

obama1
obama1

Welcome to Obama world! Suckers!

denmarks47
denmarks47

PIMCO:  PONDX FUND = You will sleep at night.

AvidNewsreader
AvidNewsreader

Well, I daresay the ones who are the most alarmed are those rich folks who are managing the funds and see their big bucks drizzling out. The rest of us are just trying to survive.

Cathconservativ
Cathconservativ

This is ridiculous.  Of course money was going to get pulled out, home values, once stable, were tanked by the government.  People were unemployed.  They had to take money out to get by or cover negative equity in their home to move for a better job.  Then there is a perverse incentive at work here where the government doesn't really mind because they get an extra 10% out of you in taxes.  It is really a tax on the people hardest hit.

But by focusing on this symptom you are masking the longer-term reality.  In a world with even 2% inflation a year, stagnant incomes, and no prospects for economic growth, there will be no retirement.  Beyond social security, even the key to private sector retirement wealth - the stock market is dependent on economic growth.  Economic growth has always been achieved through population growth and we now stand on the precipice of a population decline.  The private sector is in the early stages of contraction as a reaction to that.

The narrative of the 20th century will be that baby boomers pulled the pin on an inflation and debt bomb that created paper wealth for them.  Paper wealth they then worshiped and loved in lieu of children.  They also left us a morally bankrupt society to ruin far too many children (well those who weren't among the 55 million aborted).  

This set the stage for the 21st century narrative which is one of contraction, stagnation, a return to a more agrarian economy (see what is happening in Greece).  The reality is without a second baby boom, globally, to get the party going again, retirement is going to be a pipe dream.  We will all work until, quite literally, we die.  The baby boomers created it then took it away.

 


user1user2user3
user1user2user3

Problem solved: Just don't let people take money out of their 401k's until they hit age 59.5.... for ANY reason.

Our 401k's have been GREAT retirement plans for my wife and I. We have lived within our means and we will be retiring in our late 50's.

SteveDykstra
SteveDykstra

Hey when you decodie to make people responsible for their own accounts, this is part of it.  People can mess it up and it's their problem.  If they have to work until they're 80, or live in their child's basement, that's the consequence.  That's how this works.  We always knew it, even if we wanted to pretend that it wouldn't happen.

benmaslow
benmaslow

"If so much money earmarked for retirement is going to be pulled out early, 401(k) plans would seem to be a terribly inefficient tool."  

This is like blaming the hammer for hitting your thumb.

FancyDuker
FancyDuker

Ya'll can keep complaining till cows learn to fly ... It's not going to make a bit of difference. The bottom line is we are a country where the majority are lazy folks looking for handouts and guarantees. That's so obvious by our last election results. We let every kind of people into our country who feed off of what we hard working, born in the USA citizens built. I'd like to take what I have and get the hell outta here! Problem is no decent country wants or will allow Americans to stay but for 6 months at a time. I'm not a Democrat or Republican! I'm nopt on the left or right! I'm a basic American! I served my country in two wars, paid my taxes and never complained. I'm worried about Medicare, Social Security and the next generation who has no idea what respect, sacrifice or discipline is. Fortunately, I won't be around 30+ years from now to experience 3rd world living in the US. I'm surrounded by immigrants that live like pigs and take advantage of everything they can lay their hands on. We are all doomed, especially if you're part of the 99%. There are the haves and the have-nots and nothing left in-between. I had a pension that was dissolved. I had an IRA that I've used up just to keep up my measly lifestyle. I can barely afford food let alone rent and utilities. I use the VA for basic health care and it's the worst example of health care next to none at all! It won't be long before the country is flat broke and civil war breaks out in the streets. And now they want to take our guns away ... I give up!     

ErikB
ErikB

Ok a few thoughts. 1) Its bad of the author to assume its poor money management. Many people are dipping into this money, and its for a variety of reasons. 2) Its their money. Listen, its in a retirement vehicle but there are previsions (and penalties) to take it out, so they have a right to do so. 3) Its not "bad" and very rarely do you not come out ahead putting in enough to maximize employer match - most companies offer a 3% capped max, so even if you hate the market, you can put it in a stable fund and scoop up the match. You arent going to earn a lot in interest, but you certainly arent going to lose what some people lost. It also is tax deferred which helps with bracketing.  4). Social security is an insurance tax and the money put aside is not "yours" it is for "those who need it" which is ever changing in scope and definition making it a pain point. I personally dont mind paying 6.2% to those who are qualified to retire. 

treesonthebeach
treesonthebeach

Even Pew says a 401(k) was never meant to be a primary means of retirement.  A pension is the way, but as a whole, we have abandoned it.

swillyish
swillyish

Lol, what are the options that are better?  My mattress and the bank are certainly worse.  Social security is both seriously less efficient and likely to not exist when I could use it.  Real estate is okay, but on average worse than the stock market.  401ks look pretty good compared to the non-existent competition.

Rando
Rando

401k as an investment tool has been extremely useless for me the last 6 years. My previous employer only allowed 4 different allocations whereas my new employer allows over 20 different allocations. Still, their ROI is absolutely terrible. I only make a few hundred dollars a year using 6% contribution on 65k/yr. Unless investments start getting better, I don't foresee myself keeping a 401k. I can make way more money by having it saved up in multiple credit unions through dividends.

JaimeSusurro
JaimeSusurro

why can't people learn to budget correctly? its not that hard. learn to live within your means, and control your buying urges. good lord

krontime
krontime

at the very worst a 401k is a great way to get FREE MONEY FROM YOUR EMPLOYER through match benefits.
even with a low rate of return you're probably still doing better than any account your bank will offer and you're (gasp) actually saving your money for the future EVERY PAYCHECK.

there's nothing wrong with a properly managed 401k, i have no experience with financial management and i average double digit rate of return every year.  do your homework and take some personal accountability for your savings.

if you play fantasy football, you can manage a 401k.

in this day in age it is important to have your day to day bills, emergency fund, savings, and retirement accounted for.  if you're not doing this, you're likely complaining on this message board.

ShawnLa
ShawnLa

And George W Bush and the republicans wanted to turn social security into a 401k program.

Sneeje
Sneeje

"All this raises even more questions about 401(k) plans, which in many ways have failed Americans as a primary retirement savings vehicle."

WHAT?  Why on earth would you make that assertion instead of questioning whether Americans have failed to show the right discipline to save in the face of other needs and wants?  Saving requires sacrifice.  If a large number of Americans are in a position where they have to bleed their savings plans, it is likely that they have overspent their income over the long term and have not protected their long-term interests.  There will always be some percentage that has to reach into their savings due to tragic or unforeseen circumstances, but if it is a large number, I think it is far more likely a failure of Americans to save, regardless of the mechanism.

SethChazanoff
SethChazanoff

Who would pay the premiums for the insurance?  The 401K owner taking the loan is already in trouble.  Who would underwrite it?


Also, would this insurance help the 401K owner, or would it just serve to keep large amounts with the banks and brokers?

PhilSmith
PhilSmith

Maybe because people have to eat?

Accuteknj
Accuteknj

Poor money management my ASS, my 401K as of 2009 was about 120K, by 2012 was $0.00.  I went from a 40% pay cut at my previous job which by the way company filed for bankruptcy.  In between 2009 & 2012 two kids in College, could not afford their tuitions anymore, nor am I fanatic of goverment subzidized loans.   I would not want my kids to have a MORTAGE type payment when they graduate school.  Long story short, 401'K programs are not what they used to be, company matching programs faded away long time ago, and to keep little bit of cash in today's markets, is more riskier than playing Russian Roulette.

lewis
lewis

 because of basic money management problems ---

like loosing their homes or jobs.

Badly-Bent
Badly-Bent

So, this is what would happen if they privatized Social Security?

jchowdhury
jchowdhury

I hope this news report was not published on the request of the GOP to classify 401K as the sole retirement nest egg so that they don't have to pay Social Security.  If they succeed in doing so, not only those of us who can afford to put money into 401K will not receive any social security benefit, they will put restriction on 401K investment so that they can spend the money as theirs on other wars.  Don't worry, they will borrow money from it just as they did from Social Security.  There's too much money in 401K right now and it is a honey pot for the government.  It cannot sustain a steady growth.  Therefore, I'd support taking money out of it and do something better while there is still time.

CharlesJacques
CharlesJacques

Of course it's flowing out of 401k's. In this sustained economic slump, not Obama's fault but made worse, longer and deeper by his ideological driven mismanagement of the economy and his flat out incompetance, people are left with no choice.

tateplachecki
tateplachecki

Maybe funds are withdrawn early because the limited Fidelity fund choices provided within the company structured plan have a terrible performance history compared to the rest of the market. 

rosey1
rosey1

Articles like this only refer to people who work for corporations. There are a large cadre' of people who own their own businesses, professionals, etc. who are completely self employed. They have NO corporation that is willing to do any "matching" grants. They only have their own labors, saving philosophy and investment skills to earn their retirement.

For these people, saving, not over-spending and diversification are their only tools. For many of us, the 401k is a part of this plan. I have to frankly admit that I get a bit tired of hearing people complain when they should look into the mirror and start saving, having FEWER children and not going on expensive vacations.

I guess it is more "convenient" to always blame someone else. Self employed people don't have that option, do they?

Roycal
Roycal

Congress never intended the "401(k) plan" to be a retirement plan, as such. From a tax standpoint, it is simply a special form of tax-deferred compensation plan. The financial services industry and benefit consultants pushed the "retirement plan" concept onto the 401(k) framework, along with anti-retirement provisions borrowed from the old profit-sharing defined contribution plan, that is, a lump sum as the principal payment option, participant loans and hardship withdrawals. Those features, along with the technology that made self-directed accounts (which, contrary to the belief of many, are not inherently a part of the 401(k)'s legally required provisions) easy to manage, and the fact that there are no employer contribution (nonelective) or funding requirements, will always prevent the "401(k) plan" from fulfilling any sort meaningful "retirement plan" role for most - but certainly not all - employees.



Read more: http://business.time.com/2013/01/23/cash-leaking-out-of-401k-plans-at-alarming-rate/#ixzz2Iou9O7jp

cronins
cronins

It’s the "Me" generation at work once again. You walked away from your upside-down mortgages blaming everyone else but yourselves for the wasteland you left behind. Now you're tapping into your retirement to buy crap that you cannot afford right now. I've got news for you, you will not have social security coming your way, and you're kidding yourself if you think you will. Once retirement rolls around, you'll be the ones screaming and yelling about how the government, big business, or the rich screwed you, and how you're not getting what you "rightfully" deserve when in fact, you're getting just that.

StewartCockrell
StewartCockrell

I look at my 401k as a way to help my retirement savings and get free money out of my boss.  It isn't my only option for my retirement.  Just putting too many eggs in one basket so to speak.  You should do your 401k to get the free money and for the tax help.  But look at IRA's or stocks. Stuff that you can control your ROI better. 

ragehavoc420
ragehavoc420

Well, maybe if corporations wernt STEALING money from our 401k thi wouldnt happen, I know several people who lost most of their retirement because of that.

SeymourHolz
SeymourHolz

The problem of 401k plans hemorrhaging money through abusive transaction and maintenance fees is a bigger problem, combined with a prevailing loss of trust in financial institutions' custodial integrity in general. 

When people think their capital is going to get bled to death anyway, the feel little aversion to pulling from the system, even at the consequence of accelerated taxes and penalties. You'll have more fun facing the honest hustlers running the casinos.

KeithLivers
KeithLivers

I must say I find these sorts of articles sort of irritating. I have a 401K that I have never withdrawn money from and have had it since 1997. I have always done exactly what my two separate financial advisers told me to do (which is more or less what ever one else I know who has one has done) and it has performed miserably. So much so that when I asked my most recent manager whether when I “retired” at the age of 65 or so I would have the necessary one and a quarter million my previous adviser told me I was on track to have he simply responded: “That was based on previous assumptions.” I don't know what the average annual return/yield has been precisely, but I suspect something in the 1 to 2 percent range—or less. It would be nice if in these articles that keep being written about this subject there was some small/modest acknowledgement made that perhaps the vehicle itself (i.e., the 401K) is flawed, that, in fact, it was never meant to be the sole retirement vehicle but a supplement. Instead one invariably reads these perfunctory mentions at the beginning of the article (sotto voce) that in addition to other problems with the 401K, there is the dilemma of money leaks. A bit more candor and historical perspective concerning this very important problem would be nice.

JoeCM
JoeCM

The only reliable protection for retirement is Social Security. Bush jr and Republicans wanted to dismantle it by privatizing it and giving more profits for Wall Street companies who finance election "honorable" congress-people. Fortunately AARP fought successfully against it. 

A lot of people have problems with prudent management their finances. They buy on credit instead of saving for rainy days. When difficult time comes they are in deep trouble. This a character problem. Economic education pursued by the author helps a little bit but it can change reckless character.   

BobJan
BobJan

Since most workers haven't seen an increase in wages in years and the cost of "living" in the USA has risen dramatically what else can most people do. The people at the top of the food chain have seen their income skyrocket while keeping everyone else under their control. Since most people are happy with the "inequality" that has taken place over the years this type of problem is going to persist. If you've got a solution to these problems lets hear it.

wenchypoo
wenchypoo

Instead of offering 401k programs, why don't employers just offer to electronically debit your existing IRA account instead?  Everyone could have a cash fund inside their portfolio solely to receive these debits, then go back in and allocate the money inside as they wished.

antonmarq
antonmarq

You think that's a problem, just wait when they tax and fine you on your moneys...