Report Shows Affect of Plan Leakage on Retirement Savings

The Aon Hewitt 2010 Employer Perspectives on Defined Contribution Plan Leakage Survey included more than 1.8 million employees over 110 large defined contribution plans, a survey of 200 employers, and impact modeling from the Employee Benefit Research Institute, conducted in the years following the 2008 financial crisis. The data found that loan usage has steadily climbed; as of year-end 2010, nearly 28% of active participants had a loan outstanding, which is a record high.   

Nearly 14% of participants initiated new loans during 2010, slightly higher than previous years. The average balance of the outstanding amount was $7,860, which represented 21% of these participants’ total plan assets. Although the majority of the participants (68.3%) had only one loan outstanding, 29.2% had two loans outstanding simultaneously and 2.5% had more than two loans.   

EBRI impact modeling showed that ceasing deferrals during the loan repayment period is expected to erode future retirement income by 10% to 13%, depending on the type of enrollment (automatic or voluntary) and the participant’s income level. If two loans are taken, this reduction nearly doubles. On the other hand, if the participant continues to save during the repayment period, the loan causes little changes to expected retirement income, according to the report.  

Overall, 81.7% of participants with outstanding loans continued to defer contributions to the DC plan. However, the average savings rate of those with loans was slightly lower (6.2% of pay) than those who did not have loans outstanding (8.1% of pay).The employees who stopped deferring to the plan while repaying their loans are lower-earning individuals in their 30s or 40s, according to the report.   

Aon Hewitt found when employees with loans terminate employment nearly 70% subsequently default on the repayment. Among participants in their 20s, the default percentage jumps to nearly 80%. In contrast, on average, active employees default on their loans less than 3% of the time.  

Withdrawals  

Similar to loans, withdrawals from DC plans have increased in the wake of the 2008 financial crisis, according to the Aon Hewitt 2010 Employer Perspectives on Defined Contribution Plan Leakage Survey. During 2010, 6.9% of participants took a withdrawal, which is close to the record high of 7.1% in 2009. Before the 2008 economic downturn, only around 5% of participants took a withdrawal. Twenty percent of all withdrawals were hardships, with an average amount of $5,510. The remainder were non-hardship withdrawals, including 59½ withdrawals, with an average amount of $15,480.   

Participants with lower salaries were more apt to take withdrawals. Among participants with a salary between $20,000 and $40,000, 3.6% of participants took a hardship withdrawal and 5.9% took a non-hardship withdrawal during 2010, but only 0.5% of those earning $100,000 or more took a hardship and 3.9% took a non-hardship.Half of all employees listed avoiding a home eviction or foreclosure as the reason for the withdrawal. Education and medical bills were tied for a distant ranking of second (12.6%).   

EBRI’s Retirement Security Projection Model simulated the impact of withdrawals on DC participant retirement savings. The projection illustrates that full-career contributors who take withdrawals and stop contributing for two years thereafter reduce their retirement income by 7% to 25% depending on income and enrollment methodology.  

Cashouts  

Among workers who terminated from employment in 2010, 42% took a cash distribution, which is consistent with pre-downturn levels. Additionally, 29% left assets in the plan and 29% rolled assets over to a qualified plan.  

Among those workers with balances below $1,000, 75% took a cash distribution in the past 12 months - of course, many of these participants were forced out of the plan. But even at higher balances, a significant number cashed out. For instance, 24% of individuals with balances between $30,000 and $49,999 cashed their money out and one in 10 with balances of $100,000 or more did so.   

Younger participants were more prone to take cash distributions at termination compared to older participants, in large part due to their relatively smaller balances. More than half of people in their 20s took cash distributions in 2010, 20 percentage points higher than the rate of those ages 50 and older.  

Across the genders, women were less likely to cash out their savings and more likely to roll their savings over to another qualified vehicle.   

According to the report, cashouts have a substantial impact on savings, typically larger than loans and withdrawals. Depending on the enrollment approach, income level, and the number of job changes, participants who cashout benefits can expect to have a reduction of anywhere from a significant 11% to 67% of retirement income. The EBRI projection assumes a full-career employee takes a cash distribution from the 401(k) plan after a different number of job changes. 

Nearly 75% of employers in the Aon Hewitt 2010 Employer Perspectives on Defined Contribution Plan Leakage Survey are concerned about employee cashout behavior, and one-third have seen an increase in cashouts over the past two years. However, only 12% of employers plan on taking any action to address these worries.