PLANSPONSOR - April - May 2022 - 33

PLAN DESIGN | LEAKAGE
purchasing a home; getting divorced
or separated; incurring a large medical
expense; and facing new tuition payments.
Knowing the reasons is important,
suggests Sherri Painter, senior vice president,
retirement plan services, at Newport
Group in Pittsburgh. That way, sponsors
can proactively offer better solutions than
to drain one's account and the plan.
Education First
One proactive
solution
is education.
Employees need to be told how taking
money from their account, pre-retirement,
can reduce their capacity to save,
Painter says. She recommends that sponsors
turn to their plan's adviser, who can
explain the financial damage done by
withdrawing funds prematurely vs. the
benefits of investing long-term-notably
compounding, she says.
When a worker leaves for a new job, if
he wants to close his account, the adviser
can also stress rolling the money into an
individual retirement account or the new
employer's plan. Working together, the
sponsor and adviser can also simplify the
rollover process by instituting electronic
transfers, which minimizes the paperwork,
she adds.
Without
guidance,
participants
may rely exclusively on the written tax
information they receive when taking
their withdrawal, Painter says. But they
often misunderstand it,
the
ramifications
becoming clear only when tax time
arrives, she says.
Separating employees who do cash
out, either by choice or necessity-the
IRS requires accounts under $5,000 to
be closed-sometimes think they have
unlimited time to roll over the funds, she
says. Or they may decide that the process
seems
too complicated and use
their
windfall to pay bills instead.
The IRS, however, gives participants
60 days to roll over amounts from their
DC plan to another qualified plan or IRA.
After that, the amount becomes subject to
tax, Painter notes. " If the participants are
younger than 59.5, the withdrawal costs
them 30% in taxes-mandatory 20%
federal withholding, plus an additional
10% early distribution penalty-in addition
to state and local taxes. "
By providing targeted education when
employees are hired, and again when
they leave, sponsors should expect good
results, says Thomas Hawkins, senior vice
president of marketing and research at
Retirement Clearing House in Charlotte,
North Carolina. Education can reduce
leakage by more than 50%, he maintains.
Another cause of leakage- " often "
with the same participants-Painter says,
is having an outstanding loan when they
leave their job. Leakage happens when they
fail to pay off the loan before taking a distribution,
she says.
To stem such leakage, says Sri Reddy,
senior vice president of retirement and
income solutions at Principal Financial
Group, in Des Moines, Iowa, sponsors
should explain in advance the potential
repercussions of borrowing from one's
account and failing to repay before leaving
that job.
Costs to Participants
There is a deeper issue to address, Reddy
notes. " Recognize that there will be a
group of people who use their retirement
account as a rainy-day reserve, and those
people will take loans and withdrawals. "
He recommends plan sponsors offer an
emergency savings benefit, a dedicated
resource for times of need. To further
protect retirement savings, " we always
talk about setting up emergency saving
accounts outside of the 401(k), " he adds.
How well emergency savings accounts
work was observable during the pandemic.
Participants with a dedicated emergency
account were half as likely, in 2020, to tap
into their retirement fund, says a report
from Commonwealth and the Defined
Contribution Institutional Investment
Association's Retirement Research Center.
The study found that low- to moderateincome
respondents-i.e., those with
under $2,000 in liquid savings-were
twice as apt to have taken a 401(k) loan
or hardship withdrawal
in response to
COVID-19 than higher-income earners.
Another means to discourage
borrowing is to modify the plan's loan or
hardship policies, Painter says.
Neal Ringquist, executive vice president
and chief of sales at RCH, in fact,
says these forms of leakage should be
stopped up first.
Consider the potential damage: 82%
of plans allow for hardship distributions,
and 79.7% for at least one loan, say findings
in the 2021 PLANSPONSOR Defined
Contribution Survey. Thirty-eight percent
of plans providing for loans allow two, and
4.5% allow four or more.
Besides reducing the number of
permissible loans, many plans offer a
provision for
repaying
loans
through
payroll deduction, Painter says. Plan
sponsors may add automatic/electronic
banking for loan repayment after the
participant leaves the plan.
Painter likewise recommends plan
sponsors look at their plan's hardship
withdrawal provisions to see if those
should be tightened. Sponsors and their
advisers should encourage participants to
use the plan's loan feature before taking a
hardship withdrawal, she says. They can
do this by restricting such withdrawals
to only certain savings in the plan and
limiting the purpose for such withdrawals
to the IRS safe-harbor reasons.
Still, the sponsor needs to be careful,
Ringquist says. " It's a delicate balance
sponsors have to make. Restrict in-service
withdrawals, and participation suffers "
because participants balk at giving
up access to their money. " Make it too
liberal, and leakage increases. " The happy
medium, he says, is for sponsors to permit
only one loan at a time.
Participants contemplating a preretirement
distribution
or
loan
must
consider how desperately they really need
to use that money. " Taking a withdrawal is
" defeating one of the primary advantages of
retirement savings-that of compounding
investment returns over decades, " Painter
says. -Karen Wittwer and Noah Zuss
PLANSPONSOR.COM April - May 2022 33
http://www.PLANSPONSOR.COM
PLANSPONSOR - April - May 2022

Table of Contents for the Digital Edition of PLANSPONSOR - April - May 2022
