The new urgency for mitigating 401(k) account cash-outs

Lack of retirement preparedness has long been an area of concern for our nation. But findings in a recent study underscore that, despite all of the media coverage offering tips for how to save more for retirement, many Americans are still making a self-destructive decision that can leave them with less when they retire.

The research report Cashing Out Retirement Savings at Job Separation, released in April by the Sauder School of Business at the University of British Columbia (UBC), reviewed data for 162,360 U.S. workers who left jobs at 28 U.S. companies, and found that 41.4% of those employees chose to prematurely cash out savings from their 401(k) accounts when they left their employers. 

The researchers were understandably surprised by the high percentage of employees who cashed out upon leaving their employers, since premature cash-outs by people under 59.5 years old are subject to taxes of 10%. 

Read more: Improve retirement readiness by avoiding cash-outs and consolidating 401(k)s

However, even more surprising was the fact that nearly 90% of the U.S. workers who cashed out withdrew their entire 401(k) balance — and most of the employees who prematurely cashed out upon leaving their jobs weren't likely experiencing financial emergencies. Only 27.3% of them lost their jobs due to layoffs, terminations or other involuntary circumstances. 

Furthermore, the UBC study found that the more generous matching contributions that employers made, the more likely employees were to cash out some or all of their 401(k) savings when they left those employers. The trends it uncovered remained fairly consistent among workers of various incomes, ages and genders, and with different amounts of 401(k) savings. 

Yanwen Wang, an associate professor at the Sauder School of Business and one of the authors of the study, noted in a press release announcing the study's findings: "Sixty percent of their accrued assets will leak out of the 401(k) system when people change jobs. If you consider how often people change jobs, on average every two to five years, it means they're only left with the 401(k) balance of their last job. So people aren't saving enough for retirement." 

Wang's conclusion underscores why it is important to stem cash-out leakage. The study that she and her colleagues authored suggests that employers should educate employees about 401(k)s and the consequences of cash-outs — and that employers can also allocate portions of employee contributions to "sidecar" accounts that can help employees meet emergency expenses without having to withdraw money from their 401(k)s. 

Read more: A no-brainer retirement benefit advisers can bring to their clients

These are very valid and constructive suggestions, along with the recommendation for policymakers and employers to adopt the auto portability solution. This will help ensure that employees switching jobs will be able to seamlessly transport and consolidate their 401(k) savings into an active account in their new-employer plans automatically – so that cashing out doesn't appear to be the easiest option. 

Approximately $92 billion in savings is withdrawn from the U.S. retirement system every year due to premature cash-outs, according to the Employee Benefit Research Institute (EBRI). And, a study published by Boston College's Center for Retirement Research found that these early withdrawals reduce 401(k) plan participants' retirement income by an average of 25%.   

EBRI estimates that the auto portability solution recommended by the authors of the UBC study would preserve an additional $1.5 trillion in savings (measured in today's dollars) in our country's retirement system, if it were adopted nationwide across a 40-year period. That $1.5 trillion would include $191 billion for 21 million Black Americans, and $619 billion for all minority plan participants—making significant strides toward closing the longstanding minority wealth gap in the U.S.

Read more: Financial literacy can close the minority wealth gap for retirement savings

Auto portability — the routine and automated movement of an employee's retirement savings account with under $5,000 from their former employer's plan into an active account in their current employer's plan — has also been proven to help plan sponsors reduce cash-out leakage in their plans. A case study published in 2013 by Boston Research Group, which focused on a large plan sponsor in the healthcare services sector, found that the adoption of auto portability cut cash-outs by more than 50%, across all balances.  

The UBC study reminds us that cash-out leakage remains a big problem. However, there are solutions in place for 401(k) plan sponsors and recordkeepers to help participants avoid the all-too-easy decision to cash out their savings. Adopting them can go a long way to increasing retirement savings for millions of Americans, and bringing greater economic prosperity to many communities.