I often write about the phenomenon of cashout leakage, which occurs when participants change jobs and prematurely withdraw their retirement savings, prior to normal retirement age.
While cashout leakage represents an ongoing tragedy, the term itself is goofy, and tough to take seriously.
However, recent events indicate that the widespread adoption of auto portability will finally deliver a happy ending to the cashout leakage tragicomedy.
The Tragedy of Cashout Leakage
According to the Savings Preservation Working Group, at least 33% and as many as 47% of plan participants will cash out their retirement savings following a job change. The lost retirement savings due to cashouts amounts to between $60 billion and $105 billion annually.
For individuals affected by it, cashout leakage is tragic. This tragedy is super-easy to spot when withdrawals occur due to a true financial emergency which, in normal times, comprise about one-third of overall cashout leakage. Sadly, there’s a redemptive nature to these withdrawals, since these participants really need the funds and they need them now. Thankfully, during the COVID-19 pandemic, those affected could have temporary relief from taxes and penalties through provisions of the CARES Act.
For the remaining two-thirds of participants who’ll cash out without facing a financial emergency, their situation is also tragic, but for different reasons. These unfortunates could have avoided cashing out but instead they’ll succumb to a combination of systemic friction and poor decision-making. Ultimately, their ill-considered actions may jeopardize their prospects for a timely and comfortable retirement, and most will come to regret their decisions.
Creating a Happy Ending
Despite its tragic elements, the term “leakage” carries a certain comedic value – conjuring images of diaper-clad babies and adult undergarments. In fact, I’d be hard-pressed to coin a goofier name, unless it were referred to as ‘premature decumulation’ and likened to a treatable, non-serious affliction.
No, more humor is not called for, and will not help bring about a happy ending. A happy ending will result only when plan sponsors and their recordkeepers take concerted action to change the dynamic and provide job-changing participants with the education and assistance they require to avoid cashing out.
Auto portability – the routine, standardized, and automated movement of a retirement plan participant’s 401(k) savings account from their former employer’s plan to an active account in their current employer’s plan – offers the best ‘business case’ for widespread adoption, including supportive research, quantifiable benefits, a proven technology and an enabling regulatory framework.
Finally, with the recent announcement by Alight Solutions that they will make auto portability available to their plan sponsor clients, all the elements are falling into place for a happy ending to the tragedy of cashout leakage.