It is difficult to think of a context in which the terms “retirement” and “leakage” are a positive combination. That is certainly not the case in a financial context. A new study from the Center for Retirement Research at Boston College verifies that with respect to financial “leakage” of retirement programs.
Leakage in this case is a pre-retirement withdrawal from a retirement savings account without replacement — in other words, a permanent removal of funds that drains retirement assets. The study breaks these leakages into three categories: an in-service distribution such as a hardship withdrawal, a cash-out/lump sum distribution typically from leaving a job, and loans taken against 401(k) assets for mortgages or similar large expenses.
The study was done in conjunction with Vanguard, using 2013 data from their 401(k) assets (an approximate 10% sample of all 401(k) plans). Each category of leakage was analyzed.
- In-Service Withdrawals – In-service withdrawals totaled 1% of the collective Vanguard 401(k) assets, with 0.3% of those being hardship withdrawals consumed by expenses. Hardship withdrawals are allowed for medical/funeral expenses, post-secondary education, purchase/repair of a primary residence, or to prevent eviction/foreclosure.
The remaining 0.7% was non-hardship withdrawals, penalty-free withdrawals after age 59-1/2 but prior to retirement. However, approximately 70% of those withdrawals are for money management, rolling them over into IRAs and keeping them as retirement funds — so approximately 0.2% (30% of 0.7%) of non-hardship 401(k) withdrawals are considered leakage lost to retirement purposes. The overall leakage from in-service withdrawals is 0.5% of total funds.
- Cash-Outs – Approximately 9% of the Vanguard 401(k) participants left a job in 2013, representing 6% of total funds. The majority either kept the money in the 401(k) or rolled it over into another plan (a new employer’s plan or an IRA). However, approximately 0.5% of the total funds were cashed out.
Presumably, this was to live off during a transition; it would generally be foolish tax-wise to take a lump sum and redeposit the funds in a retirement account. Thus, the study reasonably concludes that this 0.5% represents leakage.
- Loans – Loans contain some leakage but are the most stable of the withdrawal sources, presumably because the loan is drawn out for a specific planned purchase. Of the Vanguard plans where loans against the 401(k) were available, 18% had an outstanding loan in 2013, with 11% of those taken out during that year. Loans amounted to 2% of plan assets, but due to generally good repayment practices, the leakage from loans was estimated at 0.2%.
Across all three sources, the overall leakage was 1.2% of assets. That does not sound so bad on the surface, but to illustrate the damage the analysis projected the impact on the average 401(k) balance at age sixty and determined that the 1.2% leakage produced a whopping 25% reduction in the potential 401(k) wealth. Using a set of assumptions based on the average participant starting at age thirty, the average without leakage was projected at $272,000 compared to $203,000 with leakage.
The study takes a very patrician approach to the issue, essentially arguing that policy should be changed to make it more difficult for people to remove money from 401(k)s, except for limited unpredictable hardship purposes. The report suggests that cash-out options should be eliminated entirely, which is controversial to say the least. The entire report may be found online at http://crr.bc.edu/wp-content/uploads/2015/01/IB_15-2.pdf.
We may disagree with the recommendations but we support the main premise — except for extreme cases, your savings should stay in your retirement account until you actually retire.
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