Automatic 401(k) Transfers Would Boost Workers' Savings

Summary

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Podcast Summary: WSJ Your Money Briefing

Episode: Automatic 401(k) Transfers Would Boost Workers' Savings
Date: July 15, 2020
Host: J.R. Whalen (Wall Street Journal)
Guest: Ann Tergeson (WSJ Retirement Reporter)

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Overview

This episode delves into the challenges American workers face with 401(k) savings when changing jobs, particularly during periods of economic instability like the pandemic-induced recession. The main focus is the issue of 401(k) "cash outs"—the tendency of employees, especially younger workers, to withdraw their retirement funds (incurring taxes and penalties) rather than roll them into new employer-sponsored plans. The discussion spotlights upcoming innovations, specifically automatic 401(k) transfer services, which could help close the retirement savings gap by streamlining the rollover process and making it easier for workers to protect and grow their retirement funds.

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Key Discussion Points and Insights

The Challenge of 401(k) Portability

• Frequent Job Changes and Forgotten Accounts
  • American workers, particularly younger ones, change jobs more often than in previous generations. This increases the risk that small-balance 401(k) accounts are forgotten or cashed out rather than preserved.
  • Quote [02:03]:
    “American workers do move around, and...they start 401k plans and in some cases they move after two or three years. They really don't have a lot accumulated. Maybe they leave the account behind and they forget about it. And that can be a problem.”
    — Ann Tergeson

How Automatic 401(k) Transfer Services Work

• Service Structure

  • To access the service, the employee’s new and old employers (and their plan record keepers) must both participate. If so, the worker's account can be automatically transferred to the new employer’s plan.
  • Quote [02:27]:
    “Basically, in order to have access to the service, an employee has to have an employer who signs up for it, and the record keeper who's administering the plan has to make it available...If that's the case, then the employee actually would have automatic access to this.”
    — Ann Tergeson

• Revolutionary Potential

  • The transfer service addresses the issue of small accounts being "kicked out" of 401(k) plans, often resulting in workers cashing out their balances and losing future retirement growth.
  • The service, set to launch with a major record keeper in January across over 180 large plans, could substantially reduce the leakage of retirement savings.

Current System Pitfalls

• Existing Cash-Out Practices (Timestamps [02:52]–[05:27])
  • Balances of less than $1,000: employers can force a cash-out by sending a check, tempting workers to spend rather than save.
  • $1,000–$5,000: employers can roll the funds into an IRA or the employee can cash out.
  • Over $5,000: usually allowed to remain in the plan, but workers may still cash out voluntarily.
  • Many people, “especially if they're younger and they maybe...have some pressing need, they see that money there...this is a good way to get out of whatever financial bind that I'm in.”
    — Ann Tergeson [04:59]

Cash-Outs Persist Despite Penalties

• Tax and Penalty Impact
  • Early withdrawals are taxed and penalized (10% penalty commonly), but for many, immediate needs outweigh future savings growth.
  • Quote [04:59]:
    “A lot of people, especially if they're younger and they maybe they have some pressing need, they see that money there, they think, okay, I'll have to pay the taxes and maybe in some cases often a penalty, 10% penalty. But they think, well, you know, this is a good way to get out of whatever financial bind that I'm in.”

Availability and Timing

• Who Can Use Automatic Transfer Services?
  • Not yet available everywhere; depends on whether individual employers and their plan record keepers participate.
  • Rollout begins January 2021 with a major record keeper and largest U.S. companies.
  • Quote [05:31]:
    “No, it's not. It's only available to people whose plans offer it...But starting in January, a major record keeper is actually making it available to all of the plans in their system.”

Retirement Gap and Demographics

• Potential to Address Retirement Savings Gap

  • Significant "retirement savings gap": ~$4 trillion pre-pandemic.
  • Estimates suggest eliminating premature cash-outs could recover ~$1.5 trillion, benefiting especially young and minority workers, who are more likely to cash out.
  • Quote [07:27]:
    “If employers were to close off all forms of money leaking out prematurely from these accounts, it could benefit people by about $1.5 trillion. So that's a significant portion of the $4 trillion gap right there.”
    — Ann Tergeson

• Disproportionate Impact

  • Automatic rollovers could especially help younger and minority workers:
    “Younger workers, minority workers, are more prone to actually taking money out of their accounts before retirement...if that becomes automatic and people don't have the temptation, as much temptation to cash the money out, that it could really help younger workers and minority workers shore up their retirement finances.”
    — Ann Tergeson [07:49]

Employer Initiatives

• Reducing "Leaky" 401(k)s
  • Employers now take more responsibility for closing loopholes (like easy loans or early access) and increasingly forecast lost growth for employees considering withdrawals.
  • Quote [06:23]:
    “A lot of employers are loath to tell people they can't take a loan, but...they're establishing limits on that kind of thing. And they're really trying to help people get a sense for what they're giving up if they cash out money in those accounts.”

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Notable Quotes & Memorable Moments

• On Account Forgetfulness:
  • “A lot of people may not even be completely aware that they are saving in a plan. So if they leave a company after, say, two years and they have only a couple thousand dollars in the account, they may just forget about that money.”
    — Ann Tergeson [03:36]
• On Temptation to Cash Out:
  • “[They] just see it as a way to sort of afford something, some purchase that they want to make.”
    — Ann Tergeson [05:14]
• On Reducing The Gap:
  • “There is some thought that if you have these automatic transfers...it could really help younger workers and minority workers shore up their retirement finances.”
    — Ann Tergeson [07:49]

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Important Timestamps

• 01:07: Cashing out early vs. rolling over — long-term costs
• 02:03: Why workers leave accounts behind
• 02:27: How the automatic transfer service works
• 02:52–05:27: Current rules, pitfalls, and employer practices
• 05:31: Availability of automatic transfer services
• 07:27: Impact on retirement savings gap
• 08:37: Conclusion, thanks, and wrap-up

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This episode offers practical insight into how automatic 401(k) transfer services could become crucial tools for improving American retirement security, especially for younger and more vulnerable demographic groups, by simplifying the preservation and growth of retirement savings when workers switch jobs.

Transcript

[A]

This episode is brought to you by Charles Schwab. Decisions made in Washington can affect your portfolio every day. But what policy changes should investors be watching? Washington Wise is an original podcast from Charles Schwab that unpacks the stories making news in Washington right now and how they may affect your finances and portfolio. [e-mail] WashingtonWise.

[B]

Here's your money briefing for Wednesday, July 15th. I'm J.R. whalen for the Wall Street Journal. Many of the workers who lost their jobs in the pandemic are looking for work elsewhere. In the meantime, those with 401k retirement savings might be tempted to cash out instead of rolling them over to the next job. But that comes at a steep cost.

[C]

You know, a lot of people, especially if they're younger and they maybe they have some pressing need, they see that money there, they think, ok, I'll have to pay the taxes and maybe in some case, often a penalty, 10% penalty. But they think, well, you know, this is a good way to get out of whatever financial bind that I'm in.

[B]

Cashing out early, either because you need the money or because rolling over 401k funds seems too complicated, also can cost you savings growth long term. In a moment, our retirement reporter Ann Tergeson will be here to explain services that make transferring 401 between jobs easy. That's after the break. Young workers today move from job to job a lot more often than previous generations, and when they do, instead of bringing their 401k savings with them, they're taking the cash. But soon, some employers will start offering services that automatically transfer workers 401 money between jobs. Our retirement reporter Ann Tergeson is here with me to explain how they work. So, Ann, is the need for this kind of service more pronounced than people might think? What I mean by that is younger workers today tend to change jobs frequently. We currently have millions looking for new jobs as well.

[C]

Yeah, well, I think ever since we've had 401k plans, there's been a need for this kind of thing because, I mean, American workers do move around and, you know, they start 401k plans and in some cases they move after two or three years. They really don't have a lot accumulated. Maybe they leave the account behind and they forget about it. And that can be a problem.

[B]

Now, how does the service work between an employee and their employer?

[C]

Basically, in order to have access to the service, an employee has to have an employer who signs up for it, and the record keeper who's administering the plan has to make it available. So that's sort of the first step. So there's the record keeper has to offer it and the employer has to offer it. But if that's the case, then the employee actually would have automatic access to this.

[B]

Now, what makes this service so revolutionary

[C]

right now, what happens is that if you have a 401k plan and you leave your job, whether you voluntarily leave the job or, you know you're laid off, you have to decide what to do with that money. If you have $5,000 or less, your employer actually could force you to take the money out of the account. Either they might send you a check if you have very little money in the account, effectively cashing you out, or they might actually roll that money over to an. When that happens, it can be hard for people to keep track of this money. A lot of people, especially when they're automatically enrolled in 401ks, they're not even really thinking about the money that's going into the plan. A lot of people may not even be completely aware that they are saving in a plan. So if they leave a company after say, two years and they have only a couple thousand dollars in the account, they may just forget about that money. And over time, it can grow and it can be an important source of income in retirement. So under current law, if you have less than $1,000 in your 401k account, your employer can basically send you a check for that money. I mean, they can basically kick you out of the 401k. And then when you get the check, a lot of people the temptation is to cash it, which means that you're effectively cashing out your retirement savings. Of course, you could deposit that check into an IRA and effectively roll it over, but that's up to you. A lot of people just cash it out. If you have between $1,000 and $5,000 in the account, the employer can either basically let you stay in the or they can say, you know what, we don't really want these small accounts in our 401k. They can send the money to an IRA for you, or the employee can decide to cash it out. So there's options available. If you leave a job and you have more than $5,000 in the account, the employer is required to let you Stay in the 401k if you want to. Now, a lot of people, even with larger size accounts, decide, you know what, I'd like to cash that out, I want to buy myself something new, or maybe I need to pay down debt or whatever, so they decide to cash that money out.

[B]

And even with all the taxes and penalties to go along with it, people are still cashing out.

[C]

Yeah, I mean, this is particularly the case with smaller accounts, say under $10,000. There's, you know, a lot of people, especially if they're younger and they maybe they have some pressing need, they see that money there, they think, okay, I'll have to pay the taxes and maybe in some cases often a penalty, 10% penalty. But they think, well, you know, this is a good way to get out of whatever financial bind that I'm in. And some people, you know, just see it as a way to sort of afford something, some purchase that they want to make.

[B]

Now, is this service available to anyone who changes jobs?

[C]

No, it's not. It's only available to people whose plans offer it. So that's something that right now at this moment, no plans offer it. But starting in January, a major record keeper is actually making it available to all of the plans in their system. There's over 180 of those plans and they tend to be the largest companies

[B]

in the US So leaving your money in is a wise thing to do, but that practice flies into the teeth of a recession.

[C]

So now when you see a lot of instability in the labor force, you're going to see, you are seeing, and you probably will continue to see a lot of people leaving jobs. And so this is going to be an enormous, probably source of cash outs to the 401 system during a recession. I think it can be kind of an acute thing.

[B]

Other efforts to raise concerns about the impact of cashing out 401 s on people's personal finances, you know, decades from now.

[C]

Employers have really been focusing on this in the past, you know, five, six, seven years. It didn't get a lot of attention before, but I think employers are trying to figure out a way to make now that the 401k is the main way in which people save for retirement. People don't have pensions anymore. Employers are sort of trying to make that a better system and they're trying to make it a more airtight system. A lot of employers are loath to tell people they can't take a loan, but you know, in a lot of cases, employers, rather than letting people take out two or three loans simultaneously or take out loans back to back, they're establishing limits on that kind of thing. And they're really trying to help people get a sense for what they're giving up if they cash out money in those accounts. So they might tell you, okay, you're 35 years old and you're taking out some money now in a hardship distribution, but by the time you're 60, it could be worth this much. They'll try to forecast the amount and to give people an idea of what they're really giving up.

[B]

You know, Ann, we've often heard about the retirement savings gap. Could this service help to close that?

[C]

Yeah. So there are estimates from people at Employee Benefit Research Institute, which runs a lot of modeling of retirement finances, that they say that this could really help in a tangible way close some of the retirement gap that people face. I think, you know, roughly before the recession started, they were saying the U.S. faces about a $4 trillion retirement gap. And if employers were to close off all forms of money leaking out prematurely from these accounts, it could benefit people by about $1.5 trillion. So that's a significant portion of the $4 trillion gap right there. When it comes to cash outs, there is some data that show that younger workers, minority workers, are more prone to actually taking money out of their accounts before retirement. So there is some thought that if you have these automatic transfers from your 401 account of the company you're LE to the 401k account of the company you're going to if that becomes automatic and people don't have the temptation, as much temptation to cash the money out, that it could really help younger workers and minority workers shore up their retirement finances.

[B]

All right, that's Wall Street Journal retirement reporter Ann Tergeson. Anne, thanks for coming on the show.

[C]

Sure, you're welcome.

[B]

And that's your Money briefing. I'm J.R. whalen for the Wall Street Journal.

[A]

This episode is brought to you by Charles Schwab. Decisions made in Washington can affect your portfolio every day, but what policy changes should investors be watching? Washington Wise is an original podcast from Charles Schwab that unpacks the stories making news in Washington right now and how they may affect your finances and portfolio. [e-mail] WashingtonWise.