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Think tank calls for plugging 401(k) leakage

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It’s time policymakers consider limiting 401(k) hardship withdrawals to “unpredictable” events like disability, health care emergencies or unemployment.

Also, the age for penalty-free plan withdrawals should be boosted, while lump-sum cash-outs can be eliminated by requiring that retirement assets be left in a plan or rolled over to an IRA.

So says the Center for Retirement Research at Boston College in a paper calling for consideration of these measures in the face of mounting concerns over plan leakage.

Leakage refers to any type of pre-retirement withdrawal that permanently removes money from retirement saving accounts. Over the past few decades, the potential for leakages has greatly increased because of the shift from defined benefit plans to 401(k) plans and the movement of retirement assets from 401(k)s to IRAs.

To make its point, the paper, authored by Alicia Munnell and Anthony Webb, highlighted a hypothetical saver who experiences 1.5 percent in leakage over a 30-year savings career. That saver would see their nest egg depleted by 25 percent, from $272,000 to $203,000, the paper said.

The researchers use data from Vanguard, household surveys and tax data to estimate what percentage of retirement assets leak out of plans annually.

Vanguard’s data shows that 1.2 percent of all assets leak out annually, mostly from cash-outs (0.5 percent) and hardship withdrawals (0.3 percent). 

The fund company’s data is likely conservative, say Munnell and Webb, because it only represents 10 percent of Vanguard clients and represents a pool from larger plans with likely wealthier employees less likely to experience leakage. 

Surveys of households show modestly higher rates of leakage than Vanguard’s research, while an examination of tax data shows much higher rates. 

In re-examining rules governing plan withdrawals, policymakers should balance the conflicting goals of keeping monies in plan and allowing participants access to funds when needed, say the researchers. 

While some proposals take a piecemeal approach to maintaining that balance, Munnell and Webb say, “it may be time to address leakages more comprehensively.” 

Maintaining a safety valve for hardship withdrawals “may make sense,” but they suggest excluding withdrawal needs like housing and education — what they term “predictable” events. 

That alone may make the 10 percent tax penalty on withdrawals unnecessary, they said, given that withdrawals would be allowed only in the most extreme cases of need. 

Also, raising the penalty-free withdrawal age to 62 (from 59 1/2) would align with Social Security’s earliest eligibility age of 62, the paper said. 

Cash-outs when employees change jobs could be eliminated altogether by mandating that assets stay in plan, or be rolled into a new employer’s plan or an IRA, they wrote.