Cash-Outs, Loan Defaults Hurt Retirement Savings

“Premature distributions, cash-outs of retirement accounts, and defaults on loans are major sources of DC asset leakage and were responsible for outflows of nearly $81 billion in 2014,” states Shaan Duggal, research analyst at Cerulli Associates.

“Limiting these leaks is of the utmost importance to participants and the retirement industry,” he says.

Duggal notes that nearly every participant from Generation X who completed a cash distribution from their defined contribution (DC) plan paid an additional 10% penalty, in addition to regular taxes, to the Internal Revenue Service (IRS). “When a distribution is requested, recordkeepers should spring into action, conveying the benefits of preserving the tax-deferred nature of the assets,” he says.

According to Cerulli’s report, “Evolution of the Retirement Investor 2015: Insights into Investor Segmentation and the Retirement Income Landscape,” participants older than age 50 represented almost 80% of assets that rolled over in 2014. Social Security is still the No. 1 source of anticipated guaranteed retirement income for this group of older plan participants—representing fully a third of anticipated income—while DC assets and personal savings combined provide 32.5% of participants’ income in retirement.

While loans are a smaller source of DC plan leakage, when they are defaulted, immediately they cause a taxed and penalized event for participants, Duggal points out. “Removing the entire loan function from the plan may be extreme, but restricting the amount of outstanding loans to only one will slowly do away with the idea that the DC plan is meant to be a source of short-term liquidity,” he says.

The Cerulli report reveals that distributions outpaced contributions in 2014, representing a significant turning point in the 401(k) world. Although projected assets are anticipated to grow due to market performance, recordkeepers and advisers will need to generate more out of younger employees to combat these outflows.

Savers are still interested in overall performance metrics and account balances, significantly more so than any projections of retirement income. Until this mindset changes, many participants will continue to mismanage their DC accounts, Cerulli says.