With billions of dollars continuing to leave the retirement system early every year, a new report looks at factors that lead individuals to take early withdrawals, as well as policies that may help reduce the incidence.
In “Additional Data and Analysis Could Provide Insight into Early Withdrawals,” the Government Accountability Office found that at least $29 billion left 401(k) plans in 2013 (the most recent year for which complete data is available) in the form of hardship withdrawals, cashouts at job separation and unrepaid plan loans. GAO conducted the analysis at the request of Sen. Susan Collins (R-ME), chairwoman of the Senate Special Committee on Aging, as well as the committee’s ranking Democrat, Sen. Robert Casey, Jr. (D-PA).
Specifically, the GAO found that:
- While the total amount was only a fraction of total plan assets, hardship withdrawals were the largest source of early withdrawals from 401(k) plans, with an estimated 4% of plan participants ages 25 to 55 withdrawing an aggregate $18.5 billion in 2013.
- Cashouts of account balances of $1,000 or more at job separation were the second largest source of early withdrawals. In 2013, an estimated 1.1% of plan participants ages 25 to 55 withdrew an aggregate $9.8 billion from their plans that was not rolled into another qualified plan or IRA. Additionally, GAO found that 86% of these participants taking a cashout of $1,000 or more did not roll over the amount in 2013.
- Loan defaults accounted for at least $800 million withdrawn from 401(k) plans in 2013. GAO emphasizes, however, that the amount of distributions of unpaid plan loans is probably larger, as DOL data cannot be used to quantify plan loan offsets that are deducted from participants’ account balances after they leave a plan. As a result, the amount of loan offsets among terminating participants ages 25 to 55 cannot be determined with certainty, the report explains.
While GAO conducted an exhaustive review of potential strategies to reduce leakage, the only recommendation the agency offered in the report was for the Labor Department, in coordination with IRS, to revise Form 5500 to require plan sponsors to report qualified plan loan offsets as a separate line item distinct from other types of distributions. GAO suggested that this will help to better identify the incidence and amount of loan offsets in 401(k) plans nationwide.
As part of its analysis, GAO also interviewed a range of stakeholders, including representatives of 401(k) plan sponsors, plan administrators and participant advocates. Not surprisingly, stakeholders identified flexibilities in plan rules and individuals’ “pressing financial needs,” such as out-of-pocket medical costs, as the top factors driving early withdrawals. Certain plan rules – such as setting high minimum loan thresholds – may cause individuals to take out more of their savings than needed, GAO noted. Other elements included the job separation process, difficulties transferring account balances to a new plan and plans requiring the immediate repayment of outstanding loans.
As a way to balance early access to accounts with the need to build long-term retirement savings, GAO was told that plans should consider:
- allowing individuals to continue to repay plan loans after job separation;
- restricting participant access to plan sponsor contributions;
- allowing partial or periodic distributions at job separation; and
- building emergency savings features into plan designs.
However, these stakeholders also noted that each strategy involves tradeoffs and the strategies’ broader implications require further study. Additional suggestions include modifying the current rollover process, changing hardship rules and placing limits on loan activity.
Third-party tasked with facilitating rollovers: One suggestion involved having a third-party entity tasked with facilitating rollovers between employer plans for a separating participant, where the entity would automatically route a participant’s account balance from the former plan to a new one. In fact, a similar arrangement is already in the works. GAO noted that one stakeholder cautioned, however, that direct rollovers could have downsides for some participants. For example, participants who prefer to keep their balance in their former employer’s plan but provide no direction to the plan sponsor may inadvertently find their account balance rolled into a new employer’s plan, the report explained.
Narrowing the IRS safe harbor: While some plan sponsors are expanding the list of approved reasons for a hardship withdrawal to align with perceived employee needs, some stakeholders said narrowing the IRS safe harbor would likely reduce the incidence of early withdrawals. For example, some suggested narrowing the definition of a hardship to exclude the purchase of a primary residence or for post-secondary education costs.
Replacing hardship withdrawals with hardship loans: Stakeholders believe that replacing a hardship withdrawal with a no-interest hardship loan to be repaid to the account would reduce early withdrawals. GAO explained that under this suggestion, if the loan were not repaid within this predetermined time frame, the remaining loan balance could be considered a deemed distribution and treated as income (the way a hardship withdrawal is treated now).
Limiting loan amounts to participant contributions: Some plan sponsors said they limited plan loans to participant contributions and any investment earnings from those contributions to reduce early withdrawals of retirement savings. GAO notes, for example, that one plan sponsor’s policy limited the amount a participant could borrow from the plan to 50% of the participant’s contributions and earnings, compared to 50% of the participant’s account balance.
Implementing a waiting period between loans: Some plan sponsors said they had implemented a waiting period between plan loans, in which a participant, having fully paid off the previous loan, was temporarily ineligible to apply for another. Others limit the number of outstanding plan loans to either one or two loans.