How Big is the 401(k) Cashout Leakage Problem?
We’ve known for some years now that 401(k) cashout leakage is a very big problem, but have lacked a thorough understanding of its many dimensions.
For our purposes, we used several key sources of data:
- Department of Labor Form 5500 data. This data was adjusted to derive the level of current, active participants who are presently contributing to a defined contribution plan sponsored by their employer.
- EBRI research data. Using EBRI’s database of over 25 million defined contribution participants, EBRI provided us with critical data, particularly regarding participant job turnover rates and average balances.
- Major recordkeeper cashout studies. Studies by the largest 401(k) recordkeepers provided cashout rates for multiple balance segments.
- Auto Portability Simulation. The Auto Portability Simulation integrated all of this data to order to model current and future cashout behaviors, using multiple account balance scenarios.
Using DOL Form 5500 data, we determined that there are 66.2 million active defined contribution participants.
We know from many sources (including the Bureau of Labor Statistics and the US Census Bureau) that Americans change jobs frequently. However, for our purposes, EBRI’s database gave us the most-relevant information for this population, indicating that about 14.8 million, or 22% of these participants will change jobs each year.
Applying major recordkeeper cashout studies, we found that about 4.7 million, or 31% of these job-changers, will cash out in the first year following their separation. This is what we call “fast leakage.”
The Auto Portability Simulation then modeled the additional cashout leakage that occurs in years 2-8 following separation, finding that another 1.3 million participants will cash out. This is what we refer to as “slow leakage.” Therefore, each year, a combination of fast and slow leakage results in approximately 6 million participants cashing out. Applying EBRI average balance data, we arrive at annual total of $68 billion for cashout leakage.
For a real-time depiction of the 2017 cashouts year-to-date, visit the National Retirement Savings Cash Out Clock at www.RCH1.com/national-cashout-clock.
Why Does Cashout Leakage Occur?
A popular misconception is that most 401(k) cashout leakage occurs due to financial hardship, or emergencies. However, according to a Boston Research Technologies survey of 5,000 401(k) participants, only slightly more than one-third of cashouts are for emergencies.
Another study by the Boston Research Group identified the real culprit driving the bulk of cashout leakage: friction. According to the study:
“Participants facing…’friction’ that results from complex rollover procedures and an absence of assistance take the path of least resistance and prematurely cash out at alarming rates, depleting their retirement savings and…regretting their decisions in hindsight.”
Simply put, cashing out is the easiest choice offered to job-changing participants.
Who is Affected by Cashout Leakage?
Participants with Lower Balances
The Auto Portability Simulation indicates that:
- 4 million participants, or 66% of total participants cashing out, will have balances less than $5,000.
- When we increase the balance to $10,000, it rises to 4.2 million participants.
- When we further increase the balance to $15,000, it rises to 4.5 million participants, accounting for fully 76% of participants cashing out.
- Balances greater than $15,000 account for 1.5 million participants, or 24% of our total.
Younger Ages and Lower Income Segments
A 2014 Fidelity Investments study indicated that participants who were younger and had lower incomes tended to cashout more frequently:
- Looking first at age, we find that the three youngest age cohorts all experience cashout leakage rates of greater than 30%, with the 20-29 years-old segment with 44%.
- Similarly, the three lowest income segments have cashout leakage rates of greater than 30%. The $20,000 to $30,000 segment experiences cashout leakage of 50%.
Women and Minorities
Women’s odds of cashing out are much higher, when compared to men’s, particularly for lower balance segments:
- With a small balance of $500, both Millennial and Gen Xer women will cashout at rates over 30% higher than their male counterparts.
- When the balance is increased to $2,500, the differential is still considerably higher.
African-Americans have an even larger disparity when it comes to cashout leakage, vs. their white counterparts:
- An Ariel / Aon Hewitt study found that cashouts over time, for all income levels, was 62% higher.
- Cashouts at separation, for incomes below $20,000, was 134% higher.
What are the Benefits of Reducing Cashout Leakage?
The most credible and researched initiative having the promise to considerably reduce cashout leakage is Auto Portability, which prevents leakage by automatically moving retirement savings forward to an employee’s new plan, when they change jobs.
The Auto Portability Simulation indicates that a program of retirement savings portability, when applied to balances below $5,000, will preserve $156 billion in retirement savings for 81 million participants through the year 2040. When Auto Portability is applied to balances greater than $10,000 and $15,000, the savings grow to $218 billion and $338 billion, respectively. It should be noted that these benefits reflect 2016 dollars, with no investment growth assumptions.
Following the Auto Portability Simulation, in 2017 EBRI delivered important research that further clarified the benefits of Auto Portability. Using their sophisticated modeling tools, EBRI identified the present value of Auto Portability under various timeframes and balance assumptions. When applied to small balances, EBRI projected benefits as high as $1.5 trillion. When applied to all balances, EBRI projected benefits of almost $2 trillion.
The sheer size of these benefits have firmly established Auto Portability as a leading retirement public policy initiative.
401(k) Cashout Leakage – Summary
- Each year, about 14.8 million participants will change jobs.
- 6 million of these participants will cash out completely.
- Most cashouts are not made for emergency purposes. The biggest culprit driving cashouts is friction.
- Lower balance & income segments, younger age groups, women and minorities are all disproportionately affected by cashouts.
- Auto Portability has proven benefits in reducing 401(k) cashout leakage, and with a potential $2 trillion in benefits, is a leading public policy initiative.