Abstract: Generally,
the term “leakage” has negative connotations. So, it’s not surprising
that the same is true in the context of retirement planning, where leakage
refers to pre-retirement early withdrawals from a retirement account. A
business owner who sponsors a qualified retirement plan might say, “Well,
that’s my participants’ business, not mine.” But there are valid reasons to
address the issue with employees participating in a company’s plan.
Are
you at risk of retirement plan leakage?
Generally, the term “leakage” has negative connotations. So, it’s
not surprising that the same is true in the context of retirement planning, where
leakage refers to pre-retirement early withdrawals from a retirement account. Now,
as a business owner who sponsors a qualified retirement plan, you might say,
“Well, that’s my participants’ business. Not mine.”
However, there are valid reasons to address the issue with
employees who participate in your plan.
Does it matter?
For starters, leakage can lead to higher plan expenses. Fees are
often determined on a per-account or per-participant basis. When a plan loses
funds to leakage, total assets and individual account sizes shrink, which tends
to hurt administrative efficiency and raise costs.
More broadly, if your employees are taking pre-retirement
withdrawals, it could indicate they’re facing unusual financial challenges.
These issues may have a negative impact on productivity and work quality and
leave them unable to retire when they planned to.
The stress surrounding COVID-19 may account for part of the
financial need. And more recently, the “Great Resignation” could lead some workers
to draw out retirement funds to live on or use to start a business of their
own.
What can you do?
The most important thing business owners can do to limit leakage is
to educate and remind employees about how pre-retirement withdrawals can
diminish their accounts and delay their anticipated retirement dates. While
you’re at it, consider providing broader financial education to help workers
better manage their money, amass savings, and minimize or avoid the need for
early withdrawals.
Some companies offer emergency loans that are repayable through
payroll deductions to reduce the use of retirement funds. Others have revised
their plan designs to limit the situations under which plan participants can
take out hardship withdrawals or loans.
Can you eliminate the problem?
“Roughly 22% of net contributions made by those 50 or younger leaks
out of the retirement savings system in a given year,” according to a 2021
report by the Joint Committee on Taxation. Some percentage of retirement plan
leakage will probably always occur to some extent, but
becoming aware of the problem and taking steps to minimize it are still
worthwhile for any business. We can answer questions
you might have about leakage or other aspects of plan administration and
compliance.
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