Under federal regulations, 401(k) participants may tap into their accrued retirement savings before retirement under certain circumstances, including hardship. This “leakage” from 401(k) accounts can result in a permanent loss of retirement savings.
A new report by the Government Accountability Office (GAO), 401(k) Plans: Policy Changes Could Reduce the Long-term Effects of Leakage on Workers’ Retirement Savings, suggests that Congress consider changing the requirement for the six-month contribution suspension following a hardship withdrawal. In addition, GAO recommends that the Secretary of Labor promote greater participant education on the importance of preserving retirement savings, and that the Secretary of the Treasury clarify and enhance loan exhaustion provisions to ensure that participants do not initiate unnecessary leakage through hardship withdrawals. Both agencies agreed to take actions consistent with GAO’s recommendations
Experts contacted by GAO said that certain hardship withdrawal restrictions are effectively working to reduce the overall incidence and amount of leakage, including current provisions that:
• Impose a 10 percent tax penalty on most withdrawals taken before age 59½.
• Require participants to exhaust their plan’s loan provisions before taking a hardship withdrawal.
• Require plan sponsors to preserve the tax-deferred status of accounts with balances of more than $1,000 at job separation.
However, experts told GAO that a provision requiring plans to suspend contributions to participant accounts for six months following a hardship withdrawal might exacerbate the long-term effect of leakage by barring otherwise able participants from contributing to their accounts.
In addition, GAO found that some plans are not following current hardship rules, which might result in unnecessary leakage.
The incidence and amount of the principal forms of leakage from 401(k) plans--that is, cash-outs of account balances at job separation that are not rolled over into another retirement account, hardship withdrawals, and loans--have remained relatively steady, with cash-outs having the greatest ultimate impact on participants' retirement preparedness, according to the report.
Approximately 15 percent of participants initiated some form of leakage from their retirement plans, according to an analysis of U.S. Census Bureau survey data. In addition, the incidence and amount of hardship withdrawals and loans changed little through 2008, according to data GAO received from selected major 401(k) plan administrators.
Most plans that GAO contacted used plan documents, call centers and web sites to inform participants of the short-term costs associated with the various forms of leakage, such as the tax and associated penalties. However, few plans provided them with information on the long-term negative implications that leakage can have on their retirement savings, such as the loss of compounded interest and earnings on the withdrawn amount over the course of a participant's career.
Stephen Miller is an online editor/manager for SHRM.
Related Articles—SHRM Online:
One in Four Withdraw Retirement Account Funds Early—and Pay the Price, SHRM Online Benefits Discipline, May 2008
Tapping Plan Assets, HR Magazine, May 2009
Related Resources: External
401k Plan Loans -- An Overview, 401khelpcenter.com
401k Hardship Withdrawals -- An Overview, 401khelpcenter.com
SHRM Online Benefits Discipline