Should employers be concerned if their retirement plan participants withdraw money from their accounts for non-retirement purposes? A recent report from the Joint Committee on Taxation (JCT) says yes and explains why.
The JCT report, titled “Estimating Leakage from Retirement Savings Accounts,” notes that designated retirement savings accounts generally receive favorable tax treatment under the Internal Revenue Code. “These tax subsidies are intended to encourage taxpayers to save more for retirement,” says the JCT.
However, pre-retirement withdrawals are permitted under certain circumstances — often subject to certain penalties or additional taxes. “Pre-retirement withdrawals from retirement accounts are often referred to as ‘leakage,’” the JCT notes. The agency’s report puts a spotlight on this persistent problem.
In writing “Estimating Leakage from Retirement Savings Accounts,” the JCT set out to better understand contributions to and distributions from retirement accounts. It particularly emphasized distributions to pre-retirement age individuals.
In the report, the JCT estimates leakage among working-age individuals and analyzes the extent to which certain common life events contribute to leakage. “Roughly 22% of net contributions made by those 50 or younger leaks out of the retirement savings system in a given year,” writes the JCT. “And the most prominent factor associated with leakage from retirement accounts is job separation.”
Employers should care about leakage. For starters, it can lead to higher plan expenses. Fees are often determined on a per-account or per-participant basis. When a plan loses funds to leakage, total assets and individual account sizes shrink, which tends to hurt administrative efficiency and raise costs.
More broadly, if your employees are taking pre-retirement withdrawals, it could indicate they’re facing unusual financial challenges. These usually have a negative impact on productivity and work quality. What’s more, workers who raid their accounts may be unable to retire when they reach retirement age.
Of course, the COVID-19 pandemic has put many workers in difficult financial positions. So much so that the federal government has specifically addressed retirement plan distributions in laws such as the CARES Act and the Consolidated Appropriations Act.
Perhaps the most important thing employers can do to limit leakage is educate and remind employees about how pre-retirement withdrawals can diminish their accounts and delay their anticipated retirement dates. While you’re at it, provide broader financial education to help workers better manage their money, amass savings, and minimize or avoid the need for an early withdrawal.
Some employers offer emergency loans that are repayable through payroll deductions, thus providing an avenue around the use of retirement funds. Others have revised their plan designs to reduce the number of situations under which plan participants can take out hardship withdrawals or loans.
Retirement plan leakage will probably always exist to some extent. Nonetheless, being aware of the problem and taking steps to minimize it are important measures for a plan sponsor. Contact us with any questions you might have about leakage or any other aspect of administrating your retirement plan.