By Robert C. Lawton, AIF, CRPS, President, Lawton Retirement Plan Consultants, LLC
In 2013 Time Magazine reported that one in four Americans tapped into their 401k account. Research from Fidelity indicates that 22% of participants in plans they administer have an outstanding loan. This is troubling because the high rate of 401k plan loan defaults results in annual 401k plan leakage of around $6 billion per year. Boston Research Group reports that 45% of 401k participants who leave a job take a distribution of their account balance. Significant amounts of participant balances are leaking out of 401k plans and not being replenished, with potentially disastrous results.
What is 401k plan leakage?
Leakage occurs in 401k plans when account balances permanently leave plans. Typically these amounts are never restored leaving participants with 401k balances at retirement well short of their needs. There are three types of 401k plan leakage:
- Defaulted loans. Loan defaults occur when a participant leaves a job and, rather than paying back a plan loan, decides to have the outstanding balance deducted from his/her account. Of all the types of leakage, most experts agree this is most preventable.
- Hardship withdrawals. Limited to a short list of eligible criteria, hardship withdrawals are taken by participants who run into financial difficulties. This is the most valid type of leakage and least manageable.
- Cash-outs due to separation from service. Many participants, rather than rolling their account balance into an IRA or leaving it in their former employer’s plan, decide to take a cash distribution of their account balance. This is the largest and most difficult type of leakage to manage.
Plugging 401k plan leakage
Most experts believe that the following plan design elements can limit leakage:
- If eliminating loans is not possible, limiting the number of loans participants can take to one and continuing to accept loan payments from terminated participants.
- Limiting loans and withdrawals to participant contributions only.
- Automatically restarting participant contributions after completion of the required hardship withdrawal suspension period.
In addition, the best way to reduce cash-outs is to educate your participants about the perils of leakage in your annual employee education sessions. Consider adding these plan design features today to address leakage in your 401k plan.
About the Author
Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC. Mr. Lawton has over 30 years of retirement plan consulting and administration experience and has provided consulting services to many Fortune 500 companies including: Aon Hewitt, Apple Inc., AT&T, First Interstate Bank, Florida Power & Light, General Dynamics, Houghton Mifflin Harcourt, IBM, John Deere, Mazda Motor Car Company, Northwestern Mutual, Northern Trust Company, Trek Bikes, Tribune Company, Underwriters Labs and many others. Mr. Lawton may be contacted at (414) 828-4015 or email@example.com.
Lawton Retirement Plan Consultants, LLC is a Milwaukee, Wisconsin-based independent, objective Registered Investment Advisory (RIA) firm providing investment advisory, fiduciary compliance, employee education, vendor management and plan design services to 401(k) plan sponsors. The firm currently has contracts in place to provide consulting services on more than $400 million in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or firstname.lastname@example.org or visit the firm’s website at: http://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.
This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.