By Cyril Tuohy
One of the dirty little secrets of retirement plans is that, in many cases, the savings are not being used for retirement at all.
Another unsavory truth: Financial advisors have done a poor job of guiding retirement plans to force workers to shore up their cash positions before carrying on about stocks, bonds and target date retirement accounts.
Both findings are closely related. A weak cash position forces workers to tap into retirement accounts to relieve cash flow emergencies such as an unexpected expense. Workers and plan participants then find themselves paying taxes and penalties for tapping into retirement funds early, further draining the nest eggs of Americans who already say they feel underprepared for retirement.
Instead, plan sponsors and workers would be served much better if sponsors helped workers secure a cash position first, as a default, and only then started to think about the traditional retirement account questions of growth versus income and stocks versus bonds.
These findings were published by HelloWallet, whose founder and chief executive officer Matt Fellowes and data analyst Katy Willemin conclude that a growing share of defined contribution (DC) plan participants are receiving “investment advice that is misaligned with their actual investment needs.”
Since more than 25 percent of DC participants will use all or some of their balances for non-retirement spending, the survey found, “sponsors should consider requiring their investment advisors and management services to more effectively distinguish participants that are likely to actually use their DC plans for retirement,” the authors wrote.
Spending funds allocated for retirement on household operating expenses requires workers to “breach” retirement plan assets, and the resulting decline in assets – a term known as “leakage” – cost workers and plan participants big in 2010: as much as $70 billion, according to the report titled “The Retirement Breach in Defined Contribution Plans.”
While that may not seem like much compared to a pool of $5.3 trillion in 401(k) and other DC plans and individual retirement accounts, breaching has become a “massive, systematic problem,” that affects 25 percent of all DC plan participants, the authors write.
A retirement plan breach equivalent to $70 billion annually is more than a leak, Fellowes and Willemin note. In comparison, the total amount spent by employers on matching contributions came to $118 billion, and the amount of new employee contributions annually came to $176 billion in 2010, the report said.
The biggest reason Americans break into their retirement piggy banks is to pay bills, loans or other debts (52.8 percent). Paying for housing (12.3 percent) is a distant second. General expenses, expenses while laid off and myriad other issues, from health care to education, make up the rest.
Lower-paid workers are more likely to breach their retirement plan, the study found.
Plan sponsors and administrators don't take this reality into account when recommending strategies to savers, according to Fellowes and Willemin. “Rather, tools used to create custom line-ups, target date funds, managed accounts and investment advice, generally make an unstated assumption that plan funds will be used for retirement.”
The data show that for “a large share of participants,” this is not the case at all, and DC plans and their advisors would be better off helping workers meet monthly expenses to pre-empt them from having to dip into retirement assets in the first place.
Premature erosion of retirement income due to leakage could be slowed by modifying the availability of loans and withdrawals, limiting dollars available for loans and withdrawals, simplifying loan repayment, and encouraging lifetime income options, wrote Patti Balthazor Björk, director of retirement research for AonHewitt, in a report on employee behavior in DC plans published last week.
The post-recession period has put pressure on workers to tap into retirement funds, and retirement plan leakage “remains significantly higher since pre-recession levels of 2006,” wrote Björk and colleague Rob Austin, a senior retirement consultant with Aon Hewitt.
A bill, the Shrinking Emergency Account Losses Act, co-sponsored by Sen. Bill Nelson, D-Fla., and Sen. Michael Enzi, R-Wyo., would modify the terms and requirements of taking out loans against qualified employer retirement plans.
Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. He can be reached at [email protected].
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