401(k) plans information on smartphone and IRS website

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BALTIMORE — A recent study uncovers a startling trend that could jeopardize Americans’ retirement savings. Researchers from the University of British Columbia, Texas State University, and the University of Colorado Boulder found that a significant number of employees opt to withdraw their 401(k) retirement savings when they leave a job, putting their future financial security at risk.

A 401(k) is an employer-sponsored retirement savings plan that allows employees to save a portion of their earnings for retirement, often with matching contributions from the employer. Rather than maintaining these savings for retirement, many individuals are using the funds for short-term needs or wants.

“We found that 41.4% of employees who separate from an employer with a 401(k) matching contribution withdraw savings when they leave the firm, and 85% of those cash out completely,” says Yanwen Wang, one of the study’s authors, in a statement. “This means that instead of keeping that money in savings for retirement, they’ve opted to take the money for other short-term consumption.”

The research team examined data from 2014 to 2016, which included 162,360 employees who left jobs covered by 28 different retirement plans. They discovered that the issue is largely overlooked in existing studies on retirement savings.

Muxin Zhai, another author, pointed out that the financial consequences of cashing out are not trivial. “Keep in mind that when a departing employee in America taps 401(k) savings prior to the age of 55, they must pay a 10% penalty in addition to income taxes,” she says. This means that individuals are essentially paying to access their own money, setting themselves back significantly in their retirement planning.

The researchers identified a psychological phenomenon they termed the “account composition effect.” Essentially, when a larger portion of a 401(k) balance is contributed by the employer rather than the employee, workers are more likely to view the money as a “windfall” to be spent, rather than as savings for the future. This mindset often leads them to overlook penalties and tax consequences, making rash financial decisions.

“Most firms have a blind spot about what happens at job termination and offer no financial advice to departing employees,” adds study co-author John Lynch, Jr. Instead, communication is often left to financial services firms that administer retirement plans, which usually offer only minimal guidance.

The researchers suggest that employers can play a critical role in changing this dynamic.

“If firms could deter departing employees from suddenly eyeing their hard-won savings as a free money windfall, those higher employer match rates would generate the full benefit intended to help the employee retire comfortably,” concludes Wang.

The findings underscore the importance of providing better financial education and guidance to employees, particularly as they navigate job transitions. Without this, the efforts to help employees prepare for retirement through 401(k) matching contributions could ironically be counterproductive.

The study is published in the journal INFORMS.

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1 Comment

  1. Mark says:

    This study is flawed, in its assumption that 100% of those cashing-out are spending their retirement funds. What portion of them are taking that check and rolling it over into an IRA? Tax law allows for this (so long as the deposit occurs within a certain timeframe).