The extreme fear, disruption, and volatility our nation has endured over the past several months remind us that nothing should be taken for granted. In the wake of the COVID-19 pandemic, many Americans are understandably more concerned about meeting their long-term financial goals and ensuring financial security for themselves and their families.
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A survey published in April 2020 by the National Endowment for Financial Education found that almost 90% of Americans are experiencing financial stress due to the coronavirus outbreak—and 23% of respondents identified not having enough retirement savings as one of the major concerns causing them stress.
Despite the present uncertainty, there are concrete steps Americans of all ages can take today and going forward to preserve and increase their retirement savings—ensuring they have much brighter prospects for living the lives they want to live in retirement while covering necessary expenses such as health care or long-term care.
Below are tips that everyone can follow to save more for retirement, regardless of market conditions:
Consolidate Your 401(k) Savings As You Change Jobs: The Employee Benefit Research Institute (EBRI) estimates that most Americans will switch employers at least seven times over the course of a 40-year working life.
At a time when our country’s workforce is more mobile than ever before, workers need to keep track of multiple 401(k) savings accounts.
Cashing out 401(k) assets after changing jobs can decrease retirement savings over the long term. According to a study conducted by Boston College’s Center for Retirement Research, premature withdrawals reduce your total 401(k) savings by 25% on average.
To better illustrate the loss, our team at Retirement Clearinghouse, LLC has analyzed retirement services industry data and found that a hypothetical 30-year-old worker who cashes out a $5,000 401(k) balance today would lose up to $52,000 that the $5,000 sum would have accrued, through compound interest, by the time the worker turned 65 (assuming that the account would have grown at 7% per year).
Leaving 401(k) savings behind when you change jobs can also diminish your retirement outcomes. Even though your savings remain invested in the U.S. retirement system if you leave it in your former employer’s plan, the account is still subject to fees.
New England Pension Consultants reported in its 11th annual defined contribution (DC) plan survey that the median recordkeeping fee for among DC plans is $57. If the same hypothetical 30-year-old changes jobs and leaves behind $5,000 in 401(k) savings in their prior employer’s plan, they would lose an estimated $2,052 in fees on that account over the next 35 years.
But in addition to the fees, that hypothetical worker is also forfeiting compounded savings that the $2,052 in fees would have earned. Again assuming the stranded 401(k) account would have grown by 7% per year, the $2,052 in fees on the account would have increased to $8,488.07 by the time the worker turned 65.
To maximize your retirement savings as you move from job to job, you can roll your 401(k) savings from your prior employer’s plan into the active 401(k) account in your new employer’s plan at the start of your employment. Your plan should allow it—according to the Plan Sponsor Council of America’s 61st annual survey of retirement plans, 95.6% of 401(k) plans accept rollovers from other 401(k) plans. Ask your new employer’s benefits department or plan recordkeeper about consolidating your 401(k) savings through a rollover transaction.
Keep Your Mailing Address Current in 401(k) Plan Recordkeeper Files: When you strand a 401(k) savings account in a prior employer’s plan after switching jobs, the account may not stay there forever. Under the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001, defined contribution plan sponsors have the right to automatically roll stranded 401(k) savings accounts from former employees with less than $5,000 out of their plans, and into safe-harbor IRAs. However, these investment vehicles are generally principal-protected products like money market funds, which are the only default investment choices permissible under EGTRRA.
In the current low-interest-rate environment, many principal-protected products have generated quite low returns. In fact, many safe-harbor IRAs have yielded annual interest in the range of 0.1% to 0.5%, which is lower than their fees.
According to product information in the public domain, some safe-harbor IRAs charge $50 or more in annual administration fees—well over twice the interest earned on an average $1,600 account balance with a 1% yield. You don’t have to be a mathematician to figure out what could happen to retirement savings rolled into safe-harbor IRAs.
Sponsors are required to notify former employees that their savings have been rolled into safe-harbor IRAs. But if an account holder has moved, and their new address is not recorded in the files of the plan record-keeper, then they won’t have the opportunity to prevent their 401(k) savings from being depleted in a safe-harbor IRA.
Furthermore, sponsors are permitted to automatically cash out stranded 401(k) accounts which have balances under $1,000. But once again, if an account holder has moved and the plan record-keeper doesn’t have the new address, then they won’t receive the check.
Only Tap Retirement Savings for Liquidity as a Last Resort: The fiscal stimulus signed into law in response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security (CARES) Act, waives penalties for premature 401(k) withdrawals of up to $100,000 made by December 31, 2020. These provisions are intended to help individuals, families, and businesses meet emergency expenses during this challenging time, but as mentioned above, any premature 401(k) withdrawal you make today significantly reduces the income you’ll have down the line in retirement.
To make matters worse, many 401(k) plan sponsors have been forced to end or decrease their employer contributions. According to the Plan Sponsor Council of America’s CARES Act survey, conducted in early April, 16.3% of all defined contribution plans are suspending their matching employer contributions, and 8.7% are reducing their matching contributions.
This is why, if at all possible, retirement-savers should avoid tapping their 401(k) savings as a source of short-term liquidity.
Retirement-savers need to preserve as much savings in the 401(k) plan system as possible, especially now, in order to achieve a financially secure retirement. Whatever you withdraw today will cause you to forfeit income you would have been able to access after you retire.
Following these tips throughout your working life will increase your chances of meeting your goals in retirement. Your 70-year-old self will thank you for it.
Spencer Williams is President and CEO of Retirement Clearinghouse, LLC, a provider of asset portability solutions for the retirement services industry.