Although the Vanguard study does not specifically use the term “shrinkage” – their study refers to a decline in retirement savings rates that occurs when individuals transition between jobs.
Both shrinkage and cashout leakage can lead to sub-optimal retirement outcomes. And while auto portability’s efficacy in reducing cashout leakage is well-established, it is intriguing that the Vanguard study identified auto portability as a candidate to help solve the shrinkage problem, ultimately promoting better retirement outcomes for workers.
Understanding Shrinkage
The phenomenon of shrinkage represents the reduction in retirement savings rates experienced by employees who change jobs. Despite often receiving pay increases – averaging around 10% -- these workers tend to contribute less to their retirement accounts.
The study found that on average, job switchers experience a decline in their contribution rates by approximately 0.7 percentage points after changing employers. This decline can lead to significant long-term financial consequences. A saver who changes jobs multiple times throughout their career could lose up to $300,000 in retirement savings, which equates to about six years of retirement spending.
By contrast, cashout leakage is the premature withdrawal of defined contribution retirement savings when individuals change jobs. This typically occurs when workers opt to cash out their retirement funds rather than preserving and consolidating them as their careers progress. Each year, around 40 percent of all job-changers cash out their balances, leading to a permanent loss of retirement wealth that is not recovered, severely impacting their long-term financial security.
Addressing Shrinkage with Auto Portability
Auto portability is an innovative solution specifically designed to tackle cashout leakage by facilitating the seamless transfer of small-balance (under $7,000) retirement savings between employers. Auto portability confers disproportionate benefits upon underserved and under-saved demographic segments, including lower income & younger workers, women and minorities.
To address the shrinkage problem, Vanguard proposes considering the use of “personalized defaults” – whereby a participant’s default saving rate could be set “to the higher of the plan default or the worker’s prior saving rate. This solution could involve the expansion of automatic portability via the Portability Services Network to include additional data feeds regarding the participant’s saving rate at their prior employer. This could enable savings elections to transfer from plan to plan without participant engagement.”
The Role of Innovation
Both shrinkage and cashout leakage present significant challenges to effective retirement savings strategies for American workers. While the jury is still out on whether auto portability will take on the shrinkage problem, the idea is intriguing.
Innovative solutions like PSN’s auto portability offer promising pathways to address these issues by facilitating seamless transitions between employer-sponsored plans. By adopting auto portability, plan sponsors can help ensure that employees retain their hard-earned savings and continue contributing toward a secure financial future.