However, there’s a downside to workplace retirement plan automation as well. It seems to be leaving some participants with money, but not the best money mindset.
According to Harvard economist Brigitte Madrian, “We have figured out how to get money into the retirement savings system. Now we need to think about how to keep that money in the system.”
In another example of not appreciating the value of letting 401(k) plan money grow for retirement, after leaving their company, more than 60% of 401(k) participants with balances below $10,000 liquidate their accounts, according to Retirement Clearinghouse LLC. Had they left the money in the account, transferred it to their new employer’s plan, or transferred it to an IRA, they would have avoided paying income taxes and a 10% penalty.
“When people hardly have any money in the system, it doesn’t seem worth it to them to roll it over,” said Lori Lucas, president of the Employee Benefit Research Institute.
The IRS allows hardship-related withdrawals for reasons including preventing eviction or paying medical bills. Avoiding foreclosure was the reason behind 40% of hardship withdrawals in 2023.
Such withdrawals from a traditional 401(k) plan account come with an income tax bill and, if the person making the withdrawal is younger than 59 and a half, a 10% penalty.
First, it would be helpful if new plan participants more clearly understood the importance of letting their 401(k) plan money grow for their later years.
Second, it may be helpful to find out whether new hires have an emergency fund before automatically enrolling them in a 401(k) plan. It’s generally best to build an emergency fund that contains three to six months’ worth of essential expenses before allocating money to retirement savings.
If they have the means to allocate money to an emergency fund while also contributing enough to get some or all of any available matching money, that would be ideal. However, if they can’t do both, funding the emergency savings account first would seem to be the better path.
Today, a growing number of employers are offering the option to have automatic payroll deductions used to build an emergency fund. That’s well and good, but automation alone can’t make people wise money managers. Automation plus education would be better.
Image used with permission.