As a retirement plan sponsor, one of your main objectives is to maintain employee participation and avoid retirement plan leakage. Not only does this benefit the employees, to whom you owe a fiduciary duty, but it also benefits the operating costs of the plan. After all, the larger your retirement plan, the larger your negotiating power when it comes to working with recordkeepers and investment providers.
Retirement leakage can be a tough issue to navigate since many employees don’t fully understand the ramifications of early withdrawals. According to the Congressional Joint Committee on Taxation, roughly 22% of net contributions into workplace retirement plans are withdrawn early as either a hardship withdrawal, loan, or cash-out. (1) These withdrawals result in billions of dollars lost to taxes and penalties and a decrease in employee wealth at retirement. (2)
So, how can plan sponsors tackle retirement plan leakage? It starts with employee education.
Explain the Taxes & Penalties Associated With Early Withdrawals
First and foremost, plan sponsors should take care to thoroughly explain the taxes and penalties associated with early withdrawals. While employees will be confronted with the tax and penalty withholdings when they initiate a withdrawal, it is often overlooked or too late to change their minds at that point. Instead, the drawbacks should be explained early in the retirement plan onboarding process and often thereafter.
Employees who are younger than 59½ will pay a minimum 30% in taxes for any withdrawal amount (mandatory 20% federal withholding + 10% early withdrawal penalty). (3) This amount could be even higher if they live in a state with state and local taxes to consider.
Not only do these taxes decrease the amount of money the employee has to spend, but they effectively start over with their retirement savings and lose out on years of compound growth.
Help Employees Create Emergency Savings Accounts
Though the early withdrawal penalty can be avoided by taking a loan or hardship withdrawal under certain circumstances, both of those options will still result in a reduction of the employee’s retirement savings and loss of compound growth.
One way to help employees make wise decisions when it comes to their retirement savings is to first understand why they are withdrawing funds in the first place. According to the Joint Committee, the most common reason for withdrawals is leaving a job and transferring the funds out of the old employer’s plan. (4) Beyond that, common reasons for leakage include:
- Unemployment
- Purchasing a home
- Divorce or separation
- Medical expenses
- Tuition payments
Most, if not all, of these reasons can be alleviated with a solid emergency savings account.
In fact, research from the Defined Contribution Institutional Investment Association Retirement Research Center shows that those with emergency savings accounts are half as likely to dip into retirement savings. (5) As a plan sponsor, take the time to educate your participants on the importance of an emergency savings account and help them prioritize consistent savings.
Accept Roll-in Contributions
To address cash-out leakage, be sure to inform your participants of their options for roll-in contributions. If you have employees who have come from other employers and may have amassed a significant retirement account elsewhere, let them know how important it is to consolidate retirement assets.
By allowing employees to roll their previous contributions from both other qualified plans and IRAs, you can improve their involvement in the active plan and boost your overall plan participation rates. It’s also helpful to facilitate the rollovers into the plan. The easier it is for employees to implement, the more likely they are to use it.
We’re Here to Help
Are you a plan sponsor struggling with retirement plan leakage? At DCS Pensionmark, we’re here to help plan sponsors navigate these concerns and more. We can also help you improve your employees’ ability to retire confidently. To learn more about how we can help, reach out to me by emailing dshapiro@dcspensionmark.com.
About Dan
Dan Shapiro is a retirement plan advisor and holds the Accredited Investment Fiduciary® and Certified Plan Fiduciary Advisor certifications. With over 30 years of experience in the industry, Dan guides his clients through the entire retirement plan process, from plan design to compliance to investment oversight. His goal is to provide his plan sponsor clients with the ability to offer the right retirement plan the right way to their employees—a plan they can be proud of. He is one of the original 100 Accredited Investment Fiduciary® practitioners in the United States and uses his knowledge and experience to implement best fiduciary practices to ensure employees have appropriate investments to choose from and employers have a well-documented fiduciary process in place to mitigate risk. Dan is known for taking the time to understand his clients’ unique goals and situations and applying his holistic approach to customize and develop tailored strategies to improve outcomes and take some of the plan sponsor burden off their shoulders.
When he’s not working, you can find Dan at the park and marina near his house training his Australian Shepherd. He cherishes his frequent FaceTime calls with his grown children who live in Israel. In fact, Dan and his wife, Rita, consider their proudest life achievement to be raising their two children, Ashley and Joshua, to be productive and principled adults. Dan and Rita love to entertain, especially when it includes making great food with the smoker and barbeque. To learn more about Dan, connect with him on LinkedIn.
Pensionmark Financial Group, LLC (“Pensionmark”) is an investment adviser registered under the Investment Advisers Act of 1940. Pensionmark is affiliated through common ownership with Pensionmark Securities, LLC (member SIPC).
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(1) Joint Committee on Taxation. (2021, April 26). Estimating Leakage from Retirement Savings Accounts. https://www.jct.gov/CMSPages/GetFile.aspx?guid=ed1c9da4-f180-41cd-b3f9-b8afb9531d18
(2) United States Government Accountability Office. (2019, March). Retirement Savings. https://www.gao.gov/assets/gao-19-179.pdf
(3) Internal Revenue Service. (2022, November 1). Additional Tax on Early Distributions. https://www.irs.gov/taxtopics/tc558
(4) Joint Committee on Taxation. (2021, April 26). Estimating Leakage from Retirement Savings Accounts. https://www.jct.gov/CMSPages/GetFile.aspx?guid=ed1c9da4-f180-41cd-b3f9-b8afb9531d18
(5) Cormier, Warren. (2021, January 7). Saving Through a Crisis. https://savingsproject.org/saving-through-a-crisis-lmi-retirement-plan-participants-covid-19-financial-strategies-six-months-in/