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401(k) breaches undermining retirement security for millions

By Michael A. Fletcher,January 14, 2013

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Overall, about a third of American households participate in 401(k)-type accounts, which hold a combined $3.5 trillion in assets. But a large portion of that money does not make it to retirement. A recent study by Boston College’s Center for Retirement Research found that the typical household approaching retirement age has an average of $120,000 in retirement savings, enough for roughly a $7,000-a-year annuity.

“401(k)s are not being used for retirement by a large and growing share of workers because they are misaligned with the very basic financial problems most workers face and must address,” said Fellowes of HelloWallet, which provides benefits advice to companies.

Federal policymakers and employer retirement managers have focused little on the threat to retirement security posed by premature withdrawals from savings plans and instead have worked to devise ways to get workers to put more money into the accounts at an earlier age.

In 2006, employers were given broader latitude to enroll employees in 401(k)-type plans unless workers asked not to participate. Just this year, the annual limit for 401(k)-type contributions increased from $17,000 to $17,500 for workers under age 50 and from $22,500 to $23,000 for those who are older. Meanwhile, the Saver’s Tax Credit provides up to $1,000 to help low-income workers build retirement savings.

Many employers have embraced 401(k) and other defined-contribution accounts as a way of helping workers save for retirement while relieving themselves of the financial risks that come with managing a traditional pension plan. In theory, 401(k) accounts are better suited to an economy in which workers are changing jobs more frequently than ever because the accounts can be rolled over from previous employers.

But their success depends on workers consistently contributing to them and allowing the money to stay in place throughout their careers, allowing their investment returns to compound. Many workers — particularly some earning higher salaries — do just that. But many others, who have precious little savings elsewhere, tap their retirement money as a sort of “rainy day” fund, eroding its power for the future.

Generally, workers are allowed to tap their retirement accounts for loans up to $50,000, or half their account’s value, whichever is smaller. They also can “cash out” the money when they change jobs or they can take “hardship” withdrawals, which often go to pay for housing, overdue bills or educational expenses. The cash-outs and hardship withdrawals subject account holders to taxes on the money they put into the accounts, any investment gains, and if they are under 59¹/₂ years old, a 10 percent tax penalty.

Experts warn that when workers draw on their retirement accounts to pay current bills, they put themselves at greater risk of descending into poverty upon retirement, which would leave them dependent on government programs such as subsidized housing or food stamps. Nearly 6 million senior citizens were living in or near poverty in 2010, according to a Senate committee, a number expected to increase sharply over the coming decade after a long period of decline.

HelloWallet’s report found that lower-income people, who are the most frequent users of payday loans, pawnshops and other high-cost credit outlets, were found to be those most likely to cash out their retirement plans when they changed jobs.

Using data from the Federal Reserve’s Survey of Consumer Finances and the Survey of Income and Program Participation, conducted by the Census Bureau, the report said 30 percent of households earning less than $50,000 a year had cashed out a retirement plan for non-retirement purposes. Only 12 percent of households earning between $100,000 and $150,000 a year and 8 percent of those earning more than $150,000 a year have cashed out a retirement account, the report said.

The widespread breaching of retirement accounts has led some advocates to conclude that policymakers and employers should expand their vision when thinking about their workers’ retirement needs.

Fellowes said workers would be better served by establishing emergency savings accounts that steered clear of the potential tax penalties, investment fees, and other risks and costs associated with having money in retirement accounts. Only after establishing an emergency savings fund, he said, should workers plow their money into retirement savings.

“The investment advice out there needs to recognize that a large share of participants is not going to use the money for retirement, so they should not be exposed to risky investments,” Fellowes said. “There is no investment adviser in the country who would put workers in the stock market if they were told the money being invested was for short-term needs.”

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