Improve retirement readiness by avoiding cash-outs and consolidating 401(k)s

Retired baby boomers who are saving for retirement through defined contribution (DC) plans like 401(k)s are drawing down their savings faster than their counterparts in previous generations who had pensions and other defined benefit (DB) plans, according to recent industry research. On top of that, baby boomers who may be relying solely on their DC plans may wind up with less savings for retirement than their counterparts who waited longer to withdraw savings from their defined benefit plans — and could, therefore, outlive their assets.

A July 2022 report from the Center for Retirement Research at Boston College found that, while most households whose heads were born between 1920 and 1940 had access to a defined benefit plan such as a pension, the youngest boomers, who were born in 1965, have almost no access to these types of plans. Instead, nearly all of them have access to DC plans, which are predominantly 401(k)s. 

The report notes that the 1920 to 1940 generation drew down their wealth at a much slower rate in retirement. There are multiple factors influencing this trend, such as the tendency for previous generations to preserve their savings for bequests and precautionary savings like medical expenses rather than financing their living and consumption expenses. 

Read more: How proposed legislation can help resolve retirement-savings gaps

Nevertheless, the Center for Retirement Research's study found that by age 70, retirement savers with pensions who entered retirement with $200,000 in savings had, on average, $28,000 more in assets at age 70 than retirement savers with the same amount of savings, but who had no DB plan. And, the older cohort had $86,000 more in assets by ages 75 and 80 than their counterparts without DB plan coverage. 

The Center for Retirement Research predicts that at this rate, Baby Boomers could run out of retirement savings by age 85. 

These findings underscore the importance of encouraging and enabling plan participants to maximize their retirement savings. The easiest ways for participants to improve retirement outcomes are to consolidate 401(k) savings accounts as they change employers and avoid making any premature cash-outs. 

Our research shows that a hypothetical 30-year-old plan participant who cashes out a 401(k) account with under $5,000 today would wind up forfeiting up to $52,000 in retirement savings that the balance would have accrued by age 65, if the account grew by 7% annually. Furthermore, a previous study from the Boston College's Center for Retirement Research reported that cash-outs reduce participants' income in retirement by 25% on average. 

Meanwhile, other industry research has found that leaving even one 401(k) account behind in a former-employer plan after changing jobs can cause participants to lose up to $7,000 in fees over the long term. 

Read more: Targeting small, uncashed 401(k) distribution checks can generate big savings

Besides the fees from multiple accounts, consolidating 401(k) accounts in their current, active accounts as they move from employer to employer can also help participants protect themselves and their hard-earned savings from cyber criminals. Having all of their retirement savings in a single, active account in their current employers' 401(k) plans is safer than trying to keep track of many accounts in different locations. 

Sponsors can also help participants save more for retirement, so they don't outlive their savings, by adopting auto portability, which makes it easy for them to take their 401(k) savings with them, and consolidate them in their new-employer plans, at the point of job-change. Auto portability is the routine, standardized and automated movement of an inactive participant's retirement savings account with under $5,000 from a former employer's retirement plan to an active account in their new employer's plan. 

The Employee Benefit Research Institute estimates that up to $2 trillion (measured in today's dollars) would be preserved in the U.S. retirement system if auto portability is widely adopted by sponsors over a 40-year period. This additional savings would include about $191 billion for approximately 21 million Black Americans and $619 billion for all minority participants. 

The Advancing Auto Portability Act of 2022 is the latest milestone achievement in a partnership between the private and public sectors to expand access to 401(k) plan-to-plan asset portability. Implementing auto portability, while also discouraging cash-outs from 401(k) accounts (including withdrawals to pay expenses during down markets), can help more participants increase the income they have in retirement. 

Every dollar counts when saving for retirement, especially now.