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Retirement Readiness
Take Care of Your Employees – Even When They Are Gone
Last Updated: May 18, 2023
The workplace retirement plan landscape is constantly evolving to find better ways to help workers prepare for retirement. A particularly positive evolution has been the increased use of automatic enrollment. It has been a game changer by enabling workers to participate and save at higher rates. It has been particularly helpful among lower-wage workers. According to Vanguard, 86% of workers earning less than $30k participate in their employer’s retirement plan when it has automatic enrollment, compared to only 37% of workers when the plan requires voluntary enrollment.1
Automatic enrollment gets a lot more people started on their retirement savings journey, which is great if they stay on that journey and keep the money invested. If a participant cashes out their account before retirement, they are back to square one.
There are rules in place to help minimize leakage from retirement plans, such as the common plan rule prohibiting in-service distributions unless the participant is near retirement age or facing financial hardship. However, when an employee leaves a job, and they are able to withdraw their retirement funds to use for short-term purposes, the government imposes a 10% penalty on retirement account cash-outs for participants under the age of 59 ½. They do this to discourage this practice, but a recent Harvard Business Review (HBR) study shows that this rule does not go far enough in preventing early withdrawals.2
The HBR study of over 162,000 exiting employees between 2014-2016 found that 41.4% of employees liquidated a portion of their retirement plan upon leaving, and more than 35% cashed out their entire account balance.
A likely contributor to this issue is the mandatory distribution provision commonly found in employer-sponsored retirement plans. Mandatory distributions typically apply to participants with balances below $5,000. There are many workers that would prefer to keep their money in their old 401(k) plan, but don’t have the option, and are therefore forced to make a choice.
Unfortunately, evidence shows that many choose to cash out their balance. Changing jobs is a major event that can create a lot of stress and worrying about rolling their 401(k) over to their new employer is not something they want to deal with right away. With workers having more job mobility than ever, cashing out a retirement account every time one changes jobs is a big issue.
The Potential of the New Portability Services Network (PSN)
The good news is that this problem is being addressed. The recently launched Portability Services Network (PSN) is one potential solution. The PSN is a digital hub connecting retirement plan record keepers and plan sponsors aiming to reduce cash outs by introducing auto portability for employees leaving their job with a balance under $5,000.
The PSN will act as a clearinghouse. It automatically locates a participant’s active workplace retirement account in their new employer’s plan and transfers the same participant’s old account from their prior employer’s plan into their active account with their new employer.
The PSN includes a consortium of record keepers including Alight, Empower, Fidelity, and Vanguard. It became operational in Q1 2023 and already covers 71 million workers across 143,00 employer-sponsored plans.3 In addition to helping employees, employers can greatly benefit from the PSN by reducing administrative expenses.
Moving to a new job or switching careers is a stressful life event, so offloading the mental strain of deciding on your retirement account can make a difference. Just like how automatic enrollment helps employees start saving for retirement to make the right decision with minimal friction, the PSN aims to do the same.
It is important to regularly remind ourselves of the purpose of the workplace retirement plan—to get employees on track for retirement. They can’t be prepared for retirement when they cash out their account early. It is incumbent upon retirement plan fiduciaries to do all they can to provide a plan that helps improve the financial security of their workers.
If you are a fiduciary considering joining the PSN, talk with your recordkeeper about the benefits it can have for your people. At PCI, we believe this network can be a great opportunity to make an impact and improve retirement readiness outcomes for employees.
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Sources:
1 “How America Saves 2022”, Vanguard, June 2022. https://institutional.vanguard.com/content/dam/inst/vanguard-has/insights-pdfs/22_TL_HAS_FullReport_2022.pdf.
2 Lynch, John G., Yanween Wang, and Muxin Zhai, “Too Many Employees Cash Out Their 401(k)s When Leaving a Job”, Harvard Business Review, March 7, 2023. https://hbr.org/2023/03/too-many-employees-cash-out-their-401ks-when-leaving-a-job?ab=hero-subleft-2.
3 The Portability Services Network. Accessed May 5, 2023. https://psn1.com/
Pension Consultants, Inc. is registered with the U.S. Securities and Exchange Commission as an investment adviser, located at 300 S. Campbell Ave., Springfield MO, 65806. For questions or more information contact us at 417.889.4918.
WRITTEN BY
As the Director of Participant Outcomes at Pension Consultants, Inc., Jay’s objective is to help plan sponsors get their employees on track to a successful retirement. This includes monitoring plan contributions and assessing potential changes companies can make to their retirement plan to ensure retirement readiness of their participants.
