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

NotEntitled
NotEntitled

@lMikeG Yeah, and you'd have a hard time babbling online at the office.  Just imagine.

NotEntitled
NotEntitled

@Entitled I'm still waiting for an intelligent response.

Is it The 401(k)'s fault that individuals get "battered by economic forces"?  That's what the article seemed to imply, so I'm not sure why you're arguing with my defense of the 401(k).

Is it The Employer's fault that individuals get "battered by economic forces"?  Why are we demonizing companies that provide a cost-effective means for individuals to save for their retirement?

Mr. Entitled, you even admit that 401(k) leakage is a result of the unfortunate choice of starvation or early distribution.  I don't see that as a failure of 401(k) Plans or Employers.  Do you?

You might consider this a waste of time, but look in the mirror and take care of your own life rather than blaming The System or The Man or anyone else, and then maybe my comments won't be so offensive to you, and you won't waste your time whining here.

Oh, and I've learned that in the blog world, anyone who uses the term "neo con" obviously hates big companies and capitalism to begin with.  So, why don't you just explain that in your preamble the next time you whine, so everyone can see your true colors.

Good luck, and try not to get battered while you contemplate that emergency fund idea on your next smoke break.

NotEntitled
NotEntitled

What, no intelligent responses from the entitlement class?

SarahJane
SarahJane

@TracyCapp right..  because the women that wanted to go to work were all republicans.   FYI -  quite a few jobs had pension plans and they weren't necessarily UNION jobs.  Unions are scams..  get over it.

MichaelJohnson2
MichaelJohnson2

@seasons2216: The argument in the first paragraph is faulty. In 1982 the median salary was ~$14K. In 2011 dollars that is ~$33K. In 2011 the median salary was $41K. You father's income of $40K in 1982 put him in the top 8-10% of income earners. That income in 2011 would be ~$93K. The top 8-10% income bracket in 2011 was $83K-$93K. The only thing relatively stagnant was the comparative location in the economic distribution table.

As for home prices well a $75K house in 1982 would translate into ~$204K in 2011 dollars. You would be correct in stating that a house that would be consider middle class today would be much more expensive. Perhaps. The houses today are a lot bigger than the homes were in 1982. The land value is also a premium as real estate is consumed. 

My grandmother bought a house in 1966 for $25000 (a small rancher). In 2011 dollars that would be about $174K. However today the house would sell between $250K and $350K. It sits on 2 acres in an area where only $1M+ modern homes have that type of property. It is all relative to inflation.

seasons2216
seasons2216

@obama1 And it wasn't a republican who started this, right? –––––––––––– And keep in mind, the majority of congress is republican. 

pricerj6190
pricerj6190

@Cathconservativ

You may be partially right on this one ... It was the government that caused the housing crises. See they relaxed the rules so that people could qualify for purchases they knew they could not afford. But hey ... housing values always go 'up' right? The more I borrow the more I can make ... 

Sure, Lenders and Mortgage brokers were complicit  ... but in the end it is all just simple personal greed and a complete lack of responsibility to abide by the contract you entered into in good faith. Don't buy what you can't afford and pay what you owe.

Might be wise to save 15 or 20% for a rainy day or retirement as well !

Pretty simple.

pricerj6190
pricerj6190

@user1user2user3Have to disagree ... I used a 50K$ 401K loan to payoff my house and paid myself the interest rather than Wells Fargo. Considering that I had 100k or so in low yield bond funds as a hedge in my portfolio, I paid myself more interest than I would have earned otherwise. Properly managed these loans are a great investment tool. 

Lets call it what it is ... people lack the personal discipline to pay it back and default on their responsibility. 

TheIndependent
TheIndependent

@FancyDuker How is that obvious by our last election result? I voted to keep my money out of the hands of executives and try to put it back in the workers' hands. I didn't vote to "hand out" money, as you say. And all these "hands outs" have been approved by Congress and the Senate, so you can blame the left for them if you want, but both sides have accepted and funded these programs.

Oh, and as for letting people in: Someone in your family immigrated over here. No one was born in the US, unless you're a Native American, in which case you have a right to complain about people "let in" to your country.

There are rich white people who live like pigs and take advantage of everything as well, they just wear nicer clothes as they do it. Some of the nicest guys I've met have lived in crappy houses working to shovel horse manure, and work harder than any white person I've known on a construction site.

I'm not saying we're not having problems as a country, but you're going about fixing it in the wrong way.

kevin28
kevin28

@FancyDuker  

I get what you are saying, but, who wants to take your guns away?

ErikB
ErikB

Ignore my bad spelling. Wow. Sorry just threw it up quickly.

summersorama
summersorama

@Rando That seems about right. Lets for with 4 years of contributing 6% on that salary. That gets you around 15k in contributions. A simple average of ~6% a year gets you about $900 over four years. This is back of the envelope... This thing isn't supposed to get you rich quick, its supposed to build over 25-30 years. Compounding  and dividend reinvestment results in a lot of your returns. I'd be highly skeptical of anything promsing double digit returns over a long period of time

ErikB
ErikB

Just something to consider, the amount you contribute is deferred from fed tax. So, dont forget to factor in tax savings (as opposed to paying tax on interest earned). The kicker is that at 65k you can lower your tax bracket by deferring, and then when you take the money out of the plan you pay tax - presumably at a much lower bracket beucase its your only income.

SarahJane
SarahJane

@seasons2216 @obama1 and during the Saintly Clinton Years, with the exception of a couple years, Congress/Senate was Republican.  So much so.. Clinton was considered unnecessary since there were enough votes to override a veto.

Cathconservativ
Cathconservativ

@user1user2user3 @Cathconservativ Great, so you are retiring based on investments in private equities.  Okay, so how are stocks valued?  They rise based on an expectation that future earnings of companies will increase.  How will those earnings grow without population growth and in fact, population decline?  

The answer is they won't.  Maybe you timed it right, maybe you are old enough when the cows come home it won't matter.  But the reality is, for anyone under 40, retirement may not be a possibility without a dramatic change.  But hey, if you can get yours man, right?

rb928
rb928

@pricerj6190 @user1user2user3 A loan that you paid back with after-tax money. And you'll pay taxes on that same money again when you withdraw it. And you "paid yourself interest" which means you just moved money from one of your pockets to another. The IRS loves it when people take 401k loans. More money for them.

Cathconservativ
Cathconservativ

@pricerj6190 @user1user2user3 It isn't just discipline, it is income.  Relative to inflation, salaries are back at 1970s levels and absolute salaries are starting to decline.  People in their 20s and 30s are socking money away just to have to pull it back out. 

user1user2user3
user1user2user3

@pricerj6190  The problem is is that YOU might have the discipline to pay back your loan but the majority of sheeple in this country do not have that discipline and will be relying on the govt to keep them off the streets when they retire. 


FancyDuker
FancyDuker

@TheIndependent @FancyDuker I'm not trying to fix anything. I'm just and 86 year old trying to survive! And you are correct. I'm a native American Chippewa who gets a small stipend from gambling profits. It amounts to hardly anything. I go to Walmart to buy food and watch the SNAP cards come out and pay for stuff that isn't necessary for survival. Funny how about everybody (white, black, yellow and orange) is obese! 

FancyDuker
FancyDuker

@kevin28 @FancyDuker When you are forced to register gun purchases the next step is for the gov't to round 'em up. History has a way of repeating itself. Have a look at what the German's did in the late 30's.

FancyDuker
FancyDuker

@ErikB Use Firefox as your browser. It has a built in spell checker.

listentome
listentome

@SarahJane

Ever thought how the "people just SHOULD NOT own a home" got to own a home? Isn't it the "greedy banks" that made it possible? Will you lend money to some one who has no means to pay back?

user1user2user3
user1user2user3

@Cathconservativ 

Jeeze... just chill and save your money in AAA rated muni-bonds if you're that concerned about future earnings and private equities.

Not all companies earnings are correlated to population growth.

I was your age once to and worried about the future. If you save now your and live within your means your future will take care of itself. ;-)

ErikB
ErikB

"Aint nobody got time for that"