Plug the Drain: 401(k) Leakage and the Impact on Retirement 

DCIIA Webinar

Jack VanDerhei

Research Director

Employee Benefit Research Institute

February 10, 2012

vanderhei@ebri.org

1

Key points from today’s presentation• The impact of 401(k) leakages on retirement needs to be evaluated

differently for automatic and voluntary enrollment • Voluntary enrollment

• Cash out behavior and preretirement withdrawals have a significant impact• Especially for lower income quartile

• Loans change median replacement rates by less than ½ percentage point• Does not include loan defaults

• Automatic enrollment• Lowest income quartile (with at least thirty years of eligibility)

• Cashouts will decrease probability of success by 5 percentage points• Loans will only decrease probability of success by 1 percentage point• Cashouts, hardship withdrawals (w 6 month suspension) and loans together decrease

probability of success by 6.1 percentage points• Approximately equal to a 5 year delay in participation

• Highest income quartile (with at least thirty years of eligibility)• Much more difficult to reach success threshold given the PIA formula in Social Security • Cashouts, loans and hardship withdrawals have approximately the same impact as for

lowest income quartile• However, the impact of delaying is much more significant for this group

2

3

Impact of Leakages on Voluntary Enrollment 401(k) Plans: 2002 assumptions

Loans are never taken from 401(k) plan

Preretirement withdrawals are never taken from 401(k) plan

Never cash out balance at job change

0.4

6.7

13.3

0.3

3.8

4.7

Percentage Points

Highest income Lowest income

Change in median replacement rates from 401(k) “accumulations” relative to baseline model for participants reaching age 65 between 2030 and 2039

*Median replacement rates = 50.7 and 67.2 percent for lowest and highest income quartiles respectively.Source: Holden and VanDerhei (2002).

4

6% 9% 12% 15%

Lowest, Optimistic 0.489 0.6417 0.735 0.792

Highest, Optimistic 0.289 0.41 0.53 0.64

Lowest, Pessimistic 0.457 0.5638 0.6098 0.621

Highest, Pessimistic 0.27 0.3406 0.3876 0.411

5%

15%

25%

35%

45%

55%

65%

75%

85%

Success* Rates of Achieving a Combined 80% Real Replacement Rate From Social Security and 401(k) Accumulations,as a Function of Maximum Employee Contributions

Maximum Employee Contributions

Pro

bab

ilit

y

Source: EBRI/ERF Retirement Security Projection Model, versions 100810a1–100810a16.* "Success" is defined as achieving an 80 percent real replacement rate from Social Security and 401(k) accumulations combined as defined in VanDerhei and Lucas (2010). The population simulated consists of workers currently ages 25–29 who will have more than 30 years of simulated eligibility for participation in a 401(k) plan. Workers are assumed to retire at age 65 and all 401(k) balances are converted into a real annuity at an annuity purchase price of 18.62.

5

Impact of Leakages for Automatic Enrollment Plans: Lowest Income Quartile

No leakages (82.9% prob. of success)

Cashouts

Hardship Withdrawals (HW)

HW and 6 month suspension

HW and 24 month suspension

Loans, fixed income first, no defaults

Cashouts, HW 6 month, Loans

Cashouts, HW 6, Loans (w defaults)

Delay = 1 year

Delay = 5 years

0.0%

5.1%

1.9%

2.5%

3.7%

1.0%

6.1%

7.1%

0.6%

5.9%

Percentage point decrease in probability of success* from various forms of leakages and participant behavior: under the all-optimistic auto feature assumptions

Source: EBRI Retirement Security Projection Model, version 120209.* "Success" is defined as achieving an 80 percent real replacement rate from Social Security and 401(k) accumulations combined as defined in VanDerhei and Lucas (2010). The population simulated consists of workers currently ages 25–29 who will have more than 30 years of simulated eligibility for participation in a 401(k) plan. Workers are assumed to retire at age 65 and all 401(k) balances are converted into a real annuity at an annuity purchase price of 18.62.

6

Impact of Leakages for Automatic Enrollment Plans: Highest Income Quartile

No leakages (65.2% prob. of success)

Cashouts

Hardship Withdrawals (HW)

HW and 6 month suspension

HW and 24 month suspension

Loans, fixed income first, no defaults

Cashouts, HW 6 month, Loans

Cashouts, HW 6, Loans (w defaults)

Delay = 1 year

Delay = 5 years

0.0%

4.7%

2.1%

2.7%

5.0%

1.2%

6.3%

8.2%

2.1%

14.1%

Percentage point decrease in probability of success* from various forms of leakages and participant behavior: under the all-optimistic auto feature assumptions

Source: EBRI Retirement Security Projection Model, version 120209.* "Success" is defined as achieving an 80 percent real replacement rate from Social Security and 401(k) accumulations combined as defined in VanDerhei and Lucas (2010). The population simulated consists of workers currently ages 25–29 who will have more than 30 years of simulated eligibility for participation in a 401(k) plan. Workers are assumed to retire at age 65 and all 401(k) balances are converted into a real annuity at an annuity purchase price of 18.62.

Appendix: Brief Chronology of the EBRI Retirement Security Projection Model®

• 2001, Oregono Simulated retirement wealth vs. ad hoc thresholds for

retirement expenses

• 2002, Kansas and Massachusetts o Full stochastic retiree model: Investment and

Longevity risk, Nursing home and home health care costs

o Net housing equity

• 2003, National modelo Expanded to full national sample

• 2004, Senate Aging testimony (January)o Impact of everyone saving another 5 percent of

compensation

• 2004, EBRI Policy forum (May)o Impact of annuitizing defined contribution/IRA

balances

• 2006, EBRI Issue Brief (March)o Evaluation of defined benefit freezes on participants

• 2006, EBRI Issue Brief (September)o Converted into a streamlined individual version for

the ballpark estimate Monte Carlo

• 2008, EBRI policy forum (May)o Impact of converting 401(k) plans to automatic

enrollment

• 2009, Pension Research Councilo Winners/losers analysis of defined benefit

freezes and enhanced defined contribution employer contributions provided as a quid pro quo

• 2010, EBRI Issue Brief (April)o Impact of modification of employer

contributions when they convert to automatic enrollment for 401(k) plans

o 2010, EBRI Issue Brief (July)o Updated model to 2010, included automatic

enrollment for 401(k) planso 2010, EBRI Notes (September)

o Analyzes how eligibility for participation in a DC plan impacts retirement income adequacy

o 2010, EBRI Notes (October)o Computes Retirement Savings Shortfalls for

Boomers and Gen Xerso 2010, Senate HELP testimony (October)

o Analyzes the relative importance of employer-provided retirement benefits and Social Security

o 2010, EBRI Issue Brief (November)o The Impact of Auto-enrollment and Automatic

Contribution Escalation on Retirement Income Adequacy

Appendix (continued)

o 2011, February EBRI Issue Briefo Analyzes the impact of the 2008/9 crisis

in the financial and real estate markets on retirement income adequacy

o 2011, EBRI policy forum (May)o Analyzes impact of deferring retirement

ageo 2011, July EBRI Notes article

o Analyzes the impact of the 20/20 limit recommended by the National Commission on Fiscal Responsibility and Reform

o 2011, August EBRI Notes articleo Analyzes value of defined benefit plans

o 2011, Senate Finance Hearing (September)o Analyzes the impact of modifying tax

incentives for defined contribution plans

o 2012, Urban Institute Presentation (February)o Updates RSPM to 2012o Analyzes whether Boomer

and Gen X women will be able to afford retirement at age 65

o 2012, March EBRI Notes article o Analyzes employer and

employee reaction to proposal to modify tax incentives for defined contribution plans and simulates the expected impact on account balances at retirement age

8

9

15%

20%

25%

30%

35%

40%

45%

50%

55%

60%

65%

70%

75%

80%

85%

90%

95%

100%

105%

110%

115%

120%

125%

130%

135%

140%

145%

Lowest–income quartile, all pessimistic

0 0 0 0 0 0.0217

0.0573

0.09

0.1349

0.1968

0.2645

0.3467

0.444

0.5433

0.6362

0.7085

0.7687

0.8046

0.8342

0.8599

0.8822

0.9016

0.9155

0.9271

0.9375

0.945

0.9534

Highest-income quartile, all pessimistic

0.0012

0.0076

0.0227

0.04

0.068

0.1169

0.1861

0.2772

0.3681

0.4568

0.551

0.6263

0.6914

0.7298

0.7632

0.7993

0.8266

0.8529

0.8719

0.886

0.8991

0.9079

0.9201

0.9318

0.9381

0.9442

0.9508

Lowest-income quartile, all optimistic

0 0 0 0 0 0.0194

0.046

0.0593

0.0712

0.0877

0.1097

0.1363

0.1696

0.2078

0.2547

0.3088

0.3661

0.4295

0.5019

0.5742

0.6365

0.6883

0.7288

0.765

0.7849

0.8098

0.8298

Highest-income quartile, all optimistic

0.0012

0.0073

0.0185

0.0239

0.0326

0.0441

0.056

0.076

0.1028

0.141

0.1856

0.2409

0.3001

0.3596

0.4319

0.4955

0.5493

0.6024

0.6443

0.6801

0.7104

0.7342

0.7554

0.779

0.8015

0.8178

0.8361

5%

15%

25%

35%

45%

55%

65%

75%

85%

95%

Combined Real Replacement Rate

Source: EBRI Retirement Security Projection Model, versions 100810a1–100810a16.* Cumulative distribution functions.

CDFs* of the Two Extreme Combinations of Design Variables andEmployee Response Assumptions for Employees Currently Ages 25–29 and

Assumed 31–40 Years of Eligibility, High- vs. Low-salary Quartiles

10

References

• Holden, Sarah and Jack VanDerhei. (2002). Can 401(k) Accumulations Generate Significant Income for Future Retirees?. EBRI Issue Brief and ICI Perspective

• VanDerhei, Jack and Lori Lucas, The Impact of Auto-enrollment and Automatic Contribution Escalation on Retirement Income Adequacy, November 2010 EBRI Issue Brief #349