Auto-Enrolled 401(k) Participants More Likely to Tap Their Account Balances

A new study being reported by the Wall Street Journal shows that savers who are forced to automatically enroll into 401(k) plans at their jobs (versus those who choose to enroll on their own) accrue more cash in their accounts - but are more likely to tap into them like traditional checking/savings accounts, withdrawing cash despite penalties and taxes, rather than leaving the money for its intended purpose of retirement. The article estimates this could "reduce wealth in U.S. retirement accounts by about 25%" after the savings that are lost are compounded over 30 years. 


The Journal's study found that "...within eight years of joining a 401(k) plan, the results indicate that automatically enrolled workers withdraw nearly half of the extra they manage to save, compared with workers left to sign up for the retirement plan on their own."

But the additional cash made these accounts more appealing to tap into. 

The study looked at both savings and "leakage levels" - an industry term for cash that is withdrawn from retirement accounts early - to arrive at its conclusions. It dug into the habits of 7,347 employees at a financial services company that adopted auto-enrollment on July 1, 2005. It compared those hired in the 12 months prior (without auto-enrollment) to those hired in the 12 months after (post auto-enrollment). The Wall Street Journal published the study results on Friday:

After applying the same investment returns to both groups, the study found that eight years after hire, the employees who were auto-enrolled had an average of about $1,200 more—in 2004 dollars—in their 401(k) accounts than the workers hired a year earlier who were left to sign up on their own. (The $1,200 average includes savings of both employees who left the firm before the eight years elapsed and those who stayed.)

The Journal article noted the benefits of auto-enrollment, stating that automatically enrolled plans are increasing the amount of savers and the participation rate for those putting money away. The Wall Street Journal article notes that "within 401(k) plans, auto-enrollment has boosted average participation rates above 85%, compared with 63% for plans without the feature, according to 401(k) recordkeeper Alight Solutions LLC."

However, if savers don't accrue enough cash, they often don't feel as if it is worth holding onto.

After leaving a company, just over 60% of 401(k) participants with balances below $10,000 liquidate their accounts—paying income taxes and often a 10% penalty—rather than leaving the money or transferring it to another tax-advantaged retirement plan, according to Retirement Clearinghouse LLC.

...and the larger cash balances from auto-enrolled employees make these accounts more tempting to tap into:

With more money in the plan, Prof. Madrian said, auto-enrolled employees are more likely to borrow from their 401(k) accounts over time than are workers who are required to sign up for the plan on their own. While most 401(k) borrowers repay themselves with interest, about 10% default on about $5 billion a year, according to Olivia Mitchell, an economist at the University of Pennsylvania’s Wharton School.

Despite the fact that auto-enrollment can boost savings (in this study's case, it raised the company's participation rate in its plan from 62% to 98%), the study presented evidence that these enrollees, upon leaving their job, are more likely to cash out instead of rolling their balances over. 

More than half of the auto-enrolled participants—59%—cashed-out their savings, largely driven by employees who left the company. In contrast, among the employees who joined the 401(k) voluntarily, the figure was 43%. One reason for the higher cash-out rate: While more of the auto enrolled workers saved, a greater share of their balances fell below $1,000, a level at which companies are allowed to issue checks to departing workers, many of whom cash them, said Prof. Madrian.

And the workers that don't wind up using a job switch as a prompt to tap their accounts are likely to instead take out loans against their plans. The article states that even though most borrowers repay 401(k) loans with interest, around 10% of borrowers wind up defaulting on them to the tune of nearly $5 billion per year, according to an economist University of Penn's Wharton school. 

Among the 15% who remained at the firm for eight years, 31.5% of the auto-enrolled employees had 401(k) loans outstanding, versus 26.3% for the voluntarily enrolled group. Defaults, which never exceeded 12% of employees’ total outstanding loan balances, were similar for both groups.

"Experts" have (surprise) concluded that more automation, regulation, forced financial literacy courses and forced saving is likely the answer to preventing further "leakage" and stopping workers from, well, accessing the money is theirs to begin with:

To reduce cashouts, many retirement policy experts recommend automating the process of transferring money from an old employer’s plan to a new employer’s plan; currently, departing employees who don’t want to leave money behind in a previous employer’s 401(k) plan can roll it over tax-free into an individual retirement account or a new employer’s plan, but they have to fill out paperwork. Some also favor doing away with a rule that allows companies to issue checks to departing employees with 401(k) balances below $1,000, many of whom cash the checks rather than deposit them in IRAs.

The findings may also fuel greater use of workplace wellness programs. These typically combine financial education with customized advice, delivered by apps and human advisers, to help employees develop basic money-management skills.

The article concludes by noting that some companies are now offering "emergency savings" accounts on top of 401(k) plans, to try and prevent workers from accessing their 401(k) funds. It also notes that a bill pending in congress right now may allow employers to also automatically enroll workers in these types of accounts, too.

For now, workers should be thankful they are still allowed to access the money that comes from their daily paycheck, before the government and corporations figure out the best way to force them to do something with it.