Is limiting choice the key to stop retirement leakage?

By Steven A. Morelli

“Choice” is a hot button term, but in this case perhaps not with the issue that might come to mind.

A panel discussion about retirement plan leakage at the Employee Benefit Research Institute 2022 Retirement Summit on Thursday focused on the choices employees make about their retirement savings – more specifically, the bad choices.

Broadly speaking, leakage is when money leaves retirement funds before retirement, particularly in cash-outs between jobs. According to a study of Vanguard cited by the moderator Robert Powell, founder of finStream.tv, 30% of plan participants who left their jobs took a cash out and did not put the money into an IRA. This choice by 4.5 million to 6.5 million people a year amounts to $60 billion to $105 billion, according to the study.

Should people be better educated about choices? Should choices be clearer? Should there be fewer choices? Should choices be automated? Should there be no choices? Would such a thing be unamerican? These were some of the questions the panel considered.

Is there good leakage?

In setting up the discussion, Powell said he has heard opinions ranging from 401(k) leakage being the reason why the U.S. retirement system ranks so low globally to others saying that there is no such thing as bad leakage because young people need to spend their money on their lives until income exceeds consumption, also known as the life cycle theory.

Panelist Punam Keller, management professor at the Tuck School of Business at Dartmouth College, said retirement plan leakage can be thought of as rational noncompliance.

“Good and bad is in the eye of the beholder, in this case, the decision maker,” Keller said. “Look outside in and ask people why they do things and understand their reasons, their trade-offs, their utility functions, and you will realize very quickly that their behavior, according to them, is extremely rational.”

She added that no one would say they were engaging in bad leakage behavior. Fellow panelist Steve Neeleman, HealthEquity founder and a physician, disagreed, saying that leakage from 401(k)s is bad by definition because it comes with penalties and taxes.

“Why would you want to reduce your spending power by 30% or 40% when you don't need to?” Neeleman said. “If you just allocate the right amount of money in the right bucket and then you take it out of the correct bucket, you don't have to pay a penalty and taxes.”

Panelist Dimitra Hannon, a global strategist and benefits leader at Boeing, said leakage used to be good when people had pensions as a back-up.

“The savings plan was a way to supplement that pension income, and also a way to access funds when it was needed.” Dimitra Hannon, global strategist and benefits leader at Boeing

“The savings plan was a way to supplement that pension income, and also a way to access funds when it was needed,” Hannon said, adding that almost all leakage is bad now.

Hannon said it is a large problem at her company, where 30% of its 130,000 employees have a loan out on their 401(k)s. In just one year, 11,000 workers took out service withdrawals of after-tax contributions, with some taking multiple withdrawals within a quarter.

Panelist Dan Laszlo, Millennium Trust CEO, recast the concept as necessary and unnecessary leakage.

“And everybody knows someone who's done this,” Laszlo said, describing unnecessary leakage. “They want to go on vacation, they go to their 401k, they go to their IRA, they take out their funds, and they go. Lack of education, lack of awareness, lack of thought and foresight. That’s clearly bad.”

On the other side would be pressing needs such as health care or auto repair, he said, adding that he would not characterize that as “good” leakage, but necessary.

“What we really need to get at as an industry is how we can get to solving the cause,” Laszlo said. “Leakage is probably the symptom of a big, much bigger issue. And that's what we really need to work work at together to get solved.”

Motivate or orchestrate?

It is not helpful to think about motivation, said management professor Keller, who referred to a conversation she had during the summit’s breakfast. People are not motivated to make healthy choices even though they value health, she recalled telling another attendee. People choose what feels good to them living in the moment rather than for a higher ideal.

“What did you eat for breakfast this morning?” Keller asked the attendee. “You probably went for more ‘I'm living’ versus ‘I'm eating healthy.’”

Motivation is also eroded by the complex retirement plan system where choices are not clear, she said, citing the term “rollover,” which seems to be a verb needing action but no action is required and the money can be left in the fund.

One of the answers is choice architecture, making choices clearer and optimizing the right ones, Keller said.

Neeleman, of HealthEquity, a health savings account custodian, agreed that the system makes choices difficult, citing a study that showed a third of people who cashed out 401(k)s did so because of the difficulty of rolling it over to the next job.

People are pulling from their retirement plans because they don’t have money allocated elsewhere.

He also cited another study showing that a third of Americans cannot afford $400 in emergency expenses and another one saying that a third of Americans choose not to get health care because of expenses required by their health plan. People are pulling from their retirement plans because they don’t have money allocated elsewhere.

Hannon sees the morass of choices affecting the cash-out problem from her perspective at Boeing. She suggested that choice architecture could not only make choices easier but reduce the number of them.

“If we had the technology, we could probably have some simple choice architecture in place where people can elect to just do the direct rollover,” Hannon said. “It just takes the complicated complications out of it. You don't really give them an option to cash it out.”

Hannon said technology could help automate choices. Laszlo said his company builds technology that underlies retirement fund transfer – and even his workers have trouble with all the choices.

Millennium Trust has spent more than $100 million over the past five years on a platform to move retirement accounts and will probably spend another $100 million on it in the next few years, Laszlo said. Even though his company is in the thick of the system, his employees are still confused by the choices.

“I almost have to chuckle when people in our own shop, who are in the industry processing retirement account movements day to day, still will come to me and ask me, ‘How do I fill out this?’ ‘What am I doing here?’ ‘I need to send a fax? I need to send a check? What do I even do with this?’” Laszlo said. “People who do it for a living still can't figure it out. So, it's a real problem.”

Solutions?

Automation could also help people understand the long-term consequences of the short-term gain of breaking cash out of their retirement funds, Keller said. Choice architecture can work if the choices are clear, like, for example, knowing how much money a person will lose in retirement because of taking dollars out today.

“So, you're making an informed decision,” Keller said. “It's a voluntary choice. You're making an informed decision. And it's not so complicated that you have to read 18 pages.”

Choice architecture can work if the choices are clear, like, for example, knowing how much money a person will lose in retirement because of taking dollars out today.

Keller supported the idea of auto-portability, where retirement funds automatically move to the next job, and even auto-escalation of contributions, which some large companies are adopting.

Neeleman said he generally supports pending retirement legislation in SECURE 2.0, including an allowance for auto-portability. But he chafed at forcing people out of plans and other ideas such as blocking access to the funds when a person is separated from their employer that he saw as draconian.

Neeleman did offer an example of helping employees build up health savings accounts to take care of a key reason why people break into retirement savings, paying for health expenses.

A large pharmaceutical company that HealthEquity works with just started offering an HSA plan, but with a twist. The company contributes more money to lower income workers’ funds and less to more highly compensated employees, to maximize the impact for people who would have fewer resources to deal with a health emergency and remove a temptation to use retirement funds.

Hannon said although auto-portability makes sense to transfer smaller retirement funds for job hoppers, Boeing encourages those with large accounts to leave the money in Boeing’s plan when they leave. She said those employees can more easily review their accounts in one place that way.

She returned to the importance of education and engagement, using the annual health insurance enrollment as an example, when people have to make elections each year.

“I think that on the retirement side, people should also be required on some level to engage in their retirement planning,” Hannon said. “That's the opportunity to educate them about their options about portability to understand what they really have. … There's a lot of opportunity that we're not taking advantage of as employers to reach employees during this annual enrollment time.”

A next step?

If the whole system could be scrapped and started anew, Keller said she is hearing support for a “DM” system as the next step.

“From what I'm hearing this morning, we may be going from a DB [defined benefit] to DC [defined contribution] to the DM system, and the DM is defined mandates,” Keller said. “There was a huge shift when we went from DB to DC. … Suddenly was everything is the responsibility of the employee and not the employer anymore.”

Keller described a system of structure and incentives, with carrots and sticks – carrots being education and sticks being penalties.

Neeleman later said he was uncomfortable with systems that take choice out of the hands of Americans, preferring instead a system like Amazon where people can compare options, prices and read reviews.

“I think what we're trying to do here is thread the needle between a country that is really into individual rights,” Neeleman said. “Since like 1776, we were throwing tea in the harbor, because we hated mandates. Using things like choice architecture, if it was just mandated, then it wouldn't be choice architecture, it would be architecture. … I'm all about making it easier, but I also believe we're in America, and it's hard to just shove everything down people's throats because that's when they revolt and they've been doing it for 250 years.”

Steven A. Morelli is a contributing editor for InsuranceNewsNet. He has more than 25 years of experience as a reporter and editor for newspapers and magazines. He was also vice president of communications for an insurance agents’ association. Steve can be reached at [email protected].