The gradual migration away from the traditional defined benefit pension plan and toward the new-normal of the defined contribution 401(k) plan is on its surface a paradigm shift that can only be good for corporate profits … right? Undoubtedly the offloading of the burdensome pension liability that employers previously shouldered to the ranks of employees is saving corporate employers big money in pension expense, but new data is suggesting that the new retirement-plan model is creating its own form of unintended consequences cost. The 401(k) model shifted the responsibility for retirement financial planning to the individual employee, and at the same time gave the employee the keys to the retirement savings vehicle—thus giving the individual the opportunity to drive it off the proverbial cliff. Well, that’s the employee’s problem, right? Maybe not.
Employers are starting to notice that the inadequacy of retirement savings by employees is becoming their shared problem—as under-funded aging workers are forced to try to stay on the job longer. And these more tenured employees are typically more expensive to the employer than a younger replacement worker would be. The Wall Street Journal recently reported that this additional cost is hitting the corporate bottom line, and employers are beginning to look for ways to help their employees successfully plan for and ultimately manage their own retirement.
The “Leakage” Problem
The Center for Retirement Research at Boston College published a study in 2015 analyzing the impact of 401(k) account “leakage” on employee retirement savings account balances. “Leakage” is a term used to refer to any pre-retirement withdrawal that permanently removes money from a retirement savings account, and includes common transactions such as hardship withdrawals, cash-outs at termination of employment, and defaulted 401(k) loans. Morningstar data reported in the Wall Street Journal article indicate that workers pulled $68 billion out of 401(k) accounts in 2013 for loans and cash-outs at termination of employment, up from $36 billion in 2004. The article reports that aggregate retirement savings will be reduced by approximately 25% over a 30-year compounding period as a result of these leakage events. That is an amount significant enough to be bad for both employees and their employers.
What To Do?
The data and anecdotal evidence are clear: employers cannot simply say to their employees “Here’s a 401(k) plan! Good luck!” Instead employers are realizing—whether out of altruistic concern for their workers’ well-being or their own bottom line (maybe a bit of both)—that they need to proactively work to educate plan participants regarding the behavioral and psychological challenges they face in saving for their own retirement. One report estimates that 58% of employers are currently offering help in at least one area of holistic “financial well-being.” Helping employees to understand concepts like the power of early compounding of savings, composure during periods of market volatility, and alternatives to loans from or early cash-outs of 401(k) plans can provide a powerful ounce of prevention to the troubling 401(k) leakage problem. And the offering of these types of behavioral tools is already functioning as a competitive differentiator for employers, giving those companies that are making them available to workers an advantage in attracting and retaining top talent.
The image in the lens is coming into focus: building wealth over a working career—for employees of all salary ranges but especially for those in the median to below-median salary levels—is about much more than picking the right mutual funds. If the individual is never able to manage consumption levels in order to save in the first place, or sells out at the bottom of every market correction, the prospect of achieving an adequate retirement nest-egg is illusory. Most individuals need assistance in conditioning their psychology and emotions in order to avoid behaviors that will destroy the ability to build wealth for retirement over a working career.
DataPoints has developed the industry’s first behavioral finance platform to help advisors, 401(k) plan sponsors, and their participating employees assess, understand, and manage their psychology and resulting behaviors to maximize the potential for long-term wealth-building success.