New Leeds research explains why professionals raid retirement plans when they leave their employers.
The retirement savings crisis in the United States has plenty of culprits.
John Lynch has found one in a very unlikely place.
As 401(k) plans replaced pensions, employers started matching employee contributions to their future retirements. It turns out that the more generous an employer’s match is, the more likely employees are to withdraw money from the plan when they leave a job, instead of waiting until retirement.
That greatly diminishes their savings while incurring hefty penalties—and no one is paying attention to the financial welfare of those professionals as they head out the door.
“When you go to leave your job, and you’re presented with this option to cash out, you’re more likely to think of it as free money, since your employer contributed so much to it,” Lynch said, noting it’s a mix of employee psychology and employer bureaucracy that encourages professionals to take the money and run.
Lynch, a distinguished professor of marketing at Leeds and the current executive director of the Marketing Sciences Institute, is no newcomer to problems around retirement savings. Upon arriving at Leeds in 2009, he helped create the Center for Research on Consumer Financial Decision Making, which hosts an annual conference in Boulder featuring thought leaders in industry and academia.
In one such conference, a presentation looked at leakage from retirement accounts—the kind of emerging topic the event welcomes—and Lynch was intrigued.
“It was the first I’d heard of it,” he said, “and it sounded pretty bad.”
Compounding effect of early withdrawal
Research has already turned up some sobering figures about American retirement investing. Of every dollar that makes its way into a 401(k) plan, 40 cents is withdrawn early. Not only is that subject to taxation and an IRS penalty, but people who withdraw lose the compounding effect that retirement savings can generate during the 40-plus years a person is working.
Cashing out is not an inevitable consequence when people change jobs, Lynch said. Typically, firms hire financial services “record keepers” who send form letters to departing employees, teeing up the option to withdraw money at separation. Suddenly, instead of a long-term investment in their retirement, employees see a pile of free money when they read those form letters. People took out 12.4 times as many dollars from their 401(k) accounts in the weeks after walking out the door than they did in their average 6.6 years of employment—even though the taxes and early withdrawal penalties are the same.
Lynch worked on the problem along with co-authors Yanwen Wang—now with the University of British Columbia, previously on the Leeds faculty—and Muxin Zhai, a Leeds post-doctoral researcher now with Texas State University. They studied three years’ worth of data and discovered the correlation between the generosity of employer matching and the likelihood of money being withdrawn at termination. Their analysis found 41.4 percent of employees withdrew money when they left their jobs—with most emptying their accounts.
The authors’ findings were featured earlier this month in a Harvard Business Review feature that assessed motives for cashing out early and showcased steps employers can take to help employees when they leave a job.
The study controlled not only for the size of an employee’s account, but their age, gender, income level and other factors. And while the authors weren’t able to identify the cause of each employee’s departure—in case being laid off, as opposed to taking a new position, influenced whether to withdraw money—they did look at months with high layoffs to see if there was a spike in withdrawals. For instance, during the worst of the pandemic, 1 in 6 Americans had some period of joblessness, but there was no change in the amount of leakage; in fact, research by a financial services company found the percent cashing out when leaving a job decreased very slightly during the pandemic.
“We’re not saying none of that leakage is due to need, but there’s a huge chunk that’s just psychology,” Lynch said.
Seeking simple solutions
A lot of Lynch’s past work in this arena considers the benefit of financial education, especially when that intervention takes place just before the time when you’re trying to influence behavior. When it comes to job separation, there’s usually an exit interview process, but retirement payouts typically are discussed only in a form letter from the financial services firm the employer pays to manage its plan.
It’s a vexing problem, but Lynch said he believes there’s a simple solution.
“There’s no one sitting there at the point where you’re changing jobs to say, ‘Can I help you understand your options?’” Lynch said. “It’s in an employer’s interest to do this—you want your workers to be able to enjoy retirement, otherwise you wouldn’t have given them that generous match.”
Lynch said he hopes this research gets employers to have those conversations with workers on their way out, and perhaps introduce some friction when people lean toward cashing out. There may even be direct benefits for employers—for instance, if a worker who resigns elects to keep her account in the employer’s plan, the employer may get better rates from plan administrators.
“There are some bumps in the road, in terms of maybe setting up a Roth IRA where you can’t stay in the plan or roll over to a new one. The default option can’t be to put this pile of money in front of you and let you smell it,” Lynch said. “Because once you do, you’re going to take it.”
“Cashing Out Retirement Job Savings at Job Separation” has been published online in Marketing Science, and will appear in a forthcoming print edition of the journal.