Ever change jobs and try to move your retirement savings with you? Unfortunately, this seemingly simple operation can be a real headache. There is a growing recognition that retirement plans need to become more portable. President Obama in his State of the Union address stated that if a worker “is going from job to job, he should still be able to save for retirement and take his savings with him.”
Currently, workers who wish to roll over their employer retirement plans—such as a 401(k)—face a maze of red tape, which too often involves confusing technical jargon, manual paperwork, a signature-collection scavenger hunt, multiple phone calls with retirement-plan providers, and the mailing of paper checks. It is safe to say, retirement plans have not kept pace with technology.
Understandably, workers often get frustrated by the bureaucracy and choose to simply cash out their retirement savings. In 2013, 28 percent of participants in Vanguard employer plans took lump-sum cash distributions upon leaving their employer. This is worse than it sounds. When workers opt to cash out their retirement savings instead of transferring the funds to another retirement plan or rolling them over to an Individual Retirement Account (IRA), not only do the individuals drain an important source of retirement income, but they also face additional costs.
For one, these withdrawals are immediately subject to taxes. Traditional 401(k) plans are tax-deferred investment vehicles—meaning that savings are only subject to income tax upon withdrawal—but cashing out mid-career often means that workers face a larger tax burden than if they had waited until retirement age. This is because retirees are generally taxed at a lower rate, as they tend to have lower incomes than working adults. In addition, early withdrawals (before age 59 ½) are subject to a 10-percent excise tax penalty.
Low-balance accounts are disproportionately prone to early withdrawals, due in part to federal regulations. For accounts with under $1,000 in assets, employers can actually force a participant to cash out when they leave employment, provided the employee does not take action to transfer or rollover the funds. These forced cash-outs are subject to the same taxes and penalties described above.
Employer-sponsored retirement savings should be made more easily portable. Workers should have the ability to move their funds efficiently using straightforward and secure electronic processes, and should not be forced to jump through hoops to ensure that the assets remain in a qualified plan. Simplifying and streamlining the process could help folks to preserve their nest eggs, improving retirement security for working Americans.
In the coming months, the Bipartisan Policy Center’s Commission on Retirement Security and Personal Savings will release policy recommendations that address this issue, in an effort to improve retirement security for all Americans.