FEDweek

Preventing Leaks in Your Retirement Savings

“Leakage” from retirement savings plans such as the TSP and 401(k)s is most often associated with cashing out accounts when changing jobs but it can occur in other ways as well, according to the Employee Benefit Research Institute.

Cashouts most commonly occur among those who have worked relatively few years for an employer and/or have relatively small account balances. In many cases, rather than transfer the money to an IRA or a retirement savings plan of a next employer, these are taken as straight withdrawals, incurring immediate taxation along with a tax penalty in most cases.

While the tax and penalties may be relatively small when the amount withdrawn was fairly low, retirement savings nonetheless are being depleted–especially a concern given the higher job mobility of today’s younger workers versus their older colleagues, it said.

About a third of those who cash out say they do it because they have an immediate need for the money, but the rest say that is merely a simpler option than arranging an account-to-account transfer. Of the 12.5 million people who change jobs every year, about 40 percent have less than $5,000 in their retirement account, it added.

An EBRI report said that about two-thirds of the diminishment in retirement savings due to leakage was for that reason, although taking loans and hardship withdrawals also constitute leakage.

While loans also often are characterized as a main culprit of diminished savings, they actually account for only a small portion, it added–and the option to borrow against an otherwise largely illiquid investment is seen as an incentive for individuals to invest in the first place.

It suggested that retirement savings programs make direct transfers the default choice when an employee leaves.