Under just about any circumstances, the word “leakage” has negative connotations. And so it follows that this indeed holds true for retirement planning as well.
In this context, leakage refers to early, pre-retirement withdrawals from an 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 care about the issue and perhaps address it with employees who participate in your plan.
Why it matters
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 usually have a negative impact on productivity and work quality. What’s more, workers who raid their accounts may be unable to retire when they reach retirement age.
Of course, the COVID-19 pandemic has put many people in difficult financial positions that have led them to consider withdrawing some funds from their retirement accounts. More recently, “the Great Resignation” might have some account holders pondering whether they should quit their jobs and pull out some retirement funds to live on temporarily or use to start a gig or business of their own.
What you might do
Perhaps the most important thing business owners can do to limit leakage is educate and remind employees about how pre-retirement withdrawals can diminish their accounts and delay their anticipated retirement dates. While you’re at it, provide broader financial education to help workers better manage their money, amass savings, and minimize or avoid the need for an early withdrawal.
Some companies offer emergency loans that are repayable through payroll deductions, thus providing an avenue around the use of retirement funds. Others have revised their plan designs to reduce the number of situations under which plan participants can take out hardship withdrawals or loans.
Minimize the impact
“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 released by the Joint Committee on Taxation.
Some percentage of retirement plan leakage will probably always occur to some extent. Nonetheless, being aware of the problem and taking steps to minimize it are worthy measures for any business that sponsors a qualified plan. We can answer any questions you might have about leakage or other aspects of plan administration and compliance.