401(k) Plans
Policy Changes Could Reduce the Long-term Effects of Leakage on Workers' Retirement Savings Gao ID: GAO-09-715 August 28, 2009Under federal regulations, 401(k) participants may tap into their accrued retirement savings before retirement under certain circumstances, including hardship. This "leakage" from 401(k) accounts can result in a permanent loss of retirement savings. GAO was asked to analyze (1) the incidence, amount, and relative significance of the different forms of 401(k) leakage; (2) how plans inform participants about hardship withdrawal provisions, loan provisions, and options at job separation, including the short- and long-term costs of each; and (3) how various policies may affect the incidence of leakage. To address these matters, GAO analyzed federal and 401(k) industry data and interviewed federal officials, pension experts, and plan administrators responsi- ble for managing the majority of 401(k) participants and assets.
The incidence and amount of the principal forms of leakage from 401(k) plans--that is, cashouts of account balances at job separation that are not rolled over into another retirement account, hardship withdrawals, and loans--have remained relatively steady, with cashouts having the greatest ultimate impact on participants' retirement preparedness. Approximately 15 percent of participants initiated some form of leakage from their retirement plans, according to an analysis of U.S. Census Bureau survey data collected in 1998, 2003, and 2006. In addition, the incidence and amount of hardship withdrawals and loans changed little through 2008, according to data GAO received from selected major 401(k) plan administrators. Cashouts of 401(k) accounts at job separation can result in the largest amounts of leakage and the greatest proportional loss in retirement savings. Most plans that GAO contacted used plan documents, call centers, and Web sites to inform participants of the short-term costs associated with the various forms of leakage, such as the tax and associated penalties. However, few plans provided them with information on the long-term negative implications that leakage can have on their retirement savings, such as the loss of compounded interest and earnings on the withdrawn amount over the course of a participant's career. Experts that GAO contacted said that certain provisions had all likely reduced the overall incidence and amount of leakage, including those that imposed a 10 percent tax penalty on most withdrawals taken before age 59?, required participants to exhaust their plan's loan provisions before taking a hardship withdrawal, and required plan sponsors to preserve the tax-deferred status of accounts with balances of more than $1,000 at job separation. However, experts noted that a provision requiring plans to suspend contributions to participant accounts for 6 months following a hardship withdrawal may exac-erbate the long-term effect of leakage by barring otherwise able participants from contributing to their accounts. GAO also found that some plans are not following current hardship rules, which may result in unnecessary leakage.
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Director: Team: Phone:GAO-09-715, 401 (k) Plans: Policy Changes Could Reduce the Long-term Effects of Leakage on Workers' Retirement Savings
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Report to the Chairman, Special Committee on Aging, U.S. Senate:
United States Government Accountability Office:
GAO:
August 2009:
401(k) Plans:
Policy Changes Could Reduce the Long-term Effects of Leakage on
Workers' Retirement Savings:
GAO-09-715:
GAO Highlights:
Highlights of GAO-09-715, a report to the Chairman, Special Committee
on Aging, U.S. Senate.
Why GAO Did This Study:
Under federal regulations, 401(k) participants may tap into their
accrued retirement savings before retirement under certain
circumstances, including hardship. This ’leakage“ from 401(k) accounts
can result in a permanent loss of retirement savings. GAO was asked to
analyze (1) the incidence, amount, and relative significance of the
different forms of 401(k) leakage; (2) how plans inform participants
about hardship withdrawal provisions, loan provisions, and options at
job separation, including the short- and long-term costs of each; and
(3) how various policies may affect the incidence of leakage. To
address these matters, GAO analyzed federal and 401(k) industry data
and interviewed federal officials, pension experts, and plan
administrators responsible for managing the majority of 401(k)
participants and assets.
What GAO Found:
The incidence and amount of the principal forms of leakage from 401(k)
plans”that is, cashouts of account balances at job separation that are
not rolled over into another retirement account, hardship withdrawals,
and loans”have remained relatively steady, with cashouts having the
greatest ultimate impact on participants‘ retirement preparedness.
Approximately 15 percent of participants initiated some form of leakage
from their retirement plans, according to an analysis of U.S. Census
Bureau survey data collected in 1998, 2003, and 2006. In addition, the
incidence and amount of hardship withdrawals and loans changed little
through 2008, according to data GAO received from selected major 401(k)
plan administrators. Cashouts of 401(k) accounts at job separation can
result in the largest amounts of leakage and the greatest proportional
loss in retirement savings.
Figure: Leakage as a Proportion of Overall 401(k) Plan Assets in 2006:
[Refer to PDF for image: illustration]
401(k) assets: $2.7 trillion;
* Participant contributions;
* Employer matching contributions.
Cashouts at job change: $74 billion;
Loan defaults: $561 million;
Hardship withdrawals: $9 billion.
Sources: GAO analysis of Department of Labor and Census Bureau data;
Art Explosion (images).
[End of figure]
Most plans that GAO contacted used plan documents, call centers, and
Web sites to inform participants of the short-term costs associated
with the various forms of leakage, such as the tax and associated
penalties. However, few plans provided them with information on the
long-term negative implications that leakage can have on their
retirement savings, such as the loss of compounded interest and
earnings on the withdrawn amount over the course of a participant‘s
career.
Experts that GAO contacted said that certain provisions had all likely
reduced the overall incidence and amount of leakage, including those
that imposed a 10 percent tax penalty on most withdrawals taken before
age 59½, required participants to exhaust their plan‘s loan provisions
before taking a hardship withdrawal, and required plan sponsors to
preserve the tax-deferred status of accounts with balances of more than
$1,000 at job separation. However, experts noted that a provision
requiring plans to suspend contributions to participant accounts for 6
months following a hardship withdrawal may exacerbate the long-term
effect of leakage by barring otherwise able participants from
contributing to their accounts. GAO also found that some plans are not
following current hardship rules, which may result in unnecessary
leakage.
What GAO Recommends:
GAO is suggesting that Congress consider changing the requirement for
the 6-month contribution suspension following a hardship withdrawal. In
addition, GAO recommends that the Secretary of Labor promote greater
participant education on the importance of preserving retirement
savings, and that the Secretary of the Treasury clarify and enhance
loan exhaustion provisions to ensure that participants do not initiate
unnecessary leakage through hardship withdrawals. Both agencies agreed
to take actions consistent with GAO‘s recommendations.
View [hyperlink, http://www.gao.gov/products/GAO-09-715] or key
components. For more information, contact Barbara Bovbjerg at (202) 512-
7215 or bovbjergb@gao.gov.
[End of section]
Contents:
Letter:
Background:
Leakage Has Remained Relatively Steady, with Cashouts Having the
Greatest Impact on Retirement Savings:
Plans Used Various Means to Inform Participants about Withdrawal
Provisions, but Few Alerted Them to the Negative Long-term
Implications:
Experts Said That Some Statutory Provisions Have Helped Reduce Leakage:
Conclusions:
Matter for Congressional Consideration:
Recommendations for Executive Action:
Agency Comments:
Appendix I: Scope and Methodology:
Appendix II: 401(k) Administrators That GAO Contacted:
Appendix III: Comments from the Department of Labor:
Appendix IV: Comments from the Department of the Treasury:
Appendix V: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Provisions Related to 401(k) Leakage:
Table 2: Comparison of the Rules Governing the Three Principal Forms of
401(k) Leakage:
Table 3: Recent Trends in 401(k) Leakage as Reported by Selected Major
401(k) Plan Administrators, 2005 through 2008:
Table 4: Illustration of the Effect of a $5,000 Loan, Hardship
Withdrawal, or Cashout on a Participant's 401(k) Account, by Age and
Wage Level:
Table 5: Illustration of the Effect of Cashing Out the Entire 401(k)
Account Balance at Job Separation, for Medium-Income Earners:
Table 6: Illustration of the Effect of Defaulting on a $5,000 Loan
after 1 Year of Repayment, for a Medium-Income 401(k) Participant:
Table 7: Mandatory Disclosures Provided to 401(k) Plan Participants:
Table 8: Illustration of the Effect of the Reduction in the Cashout
Amount on the Account Balance of a Medium-Income 401(k) Participant at
Age 65:
Table 9: Illustration of the Effect of Suspending Participant
Contributions Following a $5,000 Hardship Withdrawal on a Medium-Income
Participant's Account Balance at Age 65:
Figures:
Figure 1: Options Available to Participants to Withdraw Money from a
401(k) Account before Retirement:
Figure 2: Estimated Percentage of 401(k) Participants Ages 15 to 60
Reporting Leakage, by Leakage Type:
Figure 3: Estimated Total Amounts of Leakage Reported by 401(k)
Participants, Ages 15 to 60, by Leakage Type:
Figure 4: Estimated Median Amounts of Leakage Reported by 401(k)
Participants, Ages 15 to 60, by Leakage Type:
Figure 5: Illustration of 401(k) Leakage as a Proportion of Overall
401(k) Plan Assets in 2006:
Figure 6: Outstanding Participant Loan Balances and Number of Active
401(k) Participants, 1996 through 2006:
Figure 7: Loan Default Amounts Reported by 401(k) Plans, 1999 through
2006:
Figure 8: Penalty Taxes Paid on Early Withdrawals from Qualified
Retirement Plans and Average Penalty Paid, 1996 through 2006:
Figure 9: Illustration of the Effect of Removing $5,000 from a 401(k)
Account by Taking a Loan before a Hardship Withdrawal, on the Account
Balance of a Medium-Income Participant at Age 65:
Abbreviations:
DB: defined benefit:
DC: defined contribution:
ERISA: Employee Retirement Income Security Act of 1974:
EBSA: Employee Benefits Security Administration:
IRA: individual retirement account:
IRS: Internal Revenue Service:
OASDI: Old-Age, Survivors, and Disability Insurance:
SIPP: Survey of Income and Program Participation:
SMM: summary of major modifications:
SPD: summary plan description:
[End of section]
United States Government Accountability Office:
Washington, DC 20548:
August 28, 2009:
The Honorable Herb Kohl:
Chairman:
Special Committee on Aging:
United States Senate:
Dear Mr. Chairman:
The current economic recession has caused millions of U.S. workers to
lose their homes, their jobs, and significant portions of their
retirement savings. The sudden reduction in the value of retirement
savings in response to stock market declines has reportedly led many
401(k) plan participants to feel less confident in reaching their
retirement goals and to worry that they may never be able to retire.
Moreover, the rise in unemployment has had a detrimental impact on
retirement savings. For example, unemployed participants can no longer
make tax-deferred contributions to employer-sponsored plans and will
likely have more difficulty saving anything at all. In addition,
unemployment may lead participants to tap into their accrued retirement
savings to navigate difficult times. This "leakage," which can result
in the permanent loss of retirement savings, has raised concerns that
plan participants may be jeopardizing their long-term retirement
security through the short-term consumption of their retirement
savings. Such reductions in retirement savings may be even more
pronounced if the leakage occurs at a time when a participant's account
balance has already experienced market value losses.
Since they were first introduced several decades ago, 401(k) plans have
become the principal retirement savings vehicle for millions of U.S.
workers. Unlike employees with more traditional defined benefit
pensions, employees with defined contribution plans--such as 401(k)
plans--choose to participate in their employers' plans and generally
decide the amount they want to contribute and how to invest it.
[Footnote 1] Thus, they bear the responsibility for funding and
managing their investments in a way that seeks to achieve sufficient
benefits in retirement. The removal of retirement savings prior to
retirement can affect a participant's ultimate preparedness for
retirement, especially when the amounts removed are spent and not
replaced. For example, 401(k) participants who choose to take a lump-
sum distribution, or "cash out," from their account balance when
separating from their employer, rather than rolling the money over to
another qualified plan, may find it difficult to accrue sufficient
savings to provide adequate income in retirement.
In this report, we use a standard definition of leakage--that is,
participants tapping into their accrued retirement savings prior to
retirement. We do not take into account other events that could
adversely affect participant balances, such as participants not taking
advantage of the full employer matching contribution, participants
contributing less than the annual federal limit, or the costs
associated with paying plan administrative fees.[Footnote 2] In
addition, we use the term "cashout" to refer to a lump-sum distribution
made to an employee at job separation that is not subsequently rolled
over into a qualified retirement account or an individual retirement
account (IRA).[Footnote 3]
You asked us to examine several aspects of leakage from 401(k) plans.
Specifically, we answer the following questions in this report:
1. What are the incidence, amount, and relative significance of the
different forms of 401(k) leakage?
2. How do 401(k) plans inform participants about hardship withdrawal
provisions, loan provisions, and options at job separation, including
the short-term and long-term costs associated with each?
3. What is known about how various policies may affect the incidence of
401(k) leakage?
To determine the principal forms of 401(k) leakage, we interviewed
industry and academic experts, reviewed laws and regulations, and
analyzed existing studies on leakage. We then identified cashouts,
hardship withdrawals, and participant loans as the three principal
forms of leakage for the purposes of this report. To determine the
incidence and amount of leakage over time, we analyzed a cross-section
of the 3 most recent years of nationally representative survey data
collected in 1998, 2003, and 2006 in the U.S. Census Bureau's Survey of
Income and Program Participation (SIPP). We also analyzed published
annual statistics from the Department of Labor and the Internal Revenue
Service (IRS), respectively, to obtain aggregate loan default amounts
and early withdrawal penalties paid. To determine the recent prevalence
of leakage, we analyzed summary data from 2005 through 2008 that we
obtained from 401(k) plan administrators that represent about 22
million 401(k) participants and over $1 trillion in 401(k) plan assets.
To illustrate the relative significance of leakage over time, we
developed scenarios to simulate the effect that various forms and
amounts of leakage may have on retirement savings. In developing these
scenarios, we considered a range of factors, including historical and
projected rates of return, earnings, wages, contribution rates, years
until retirement, loan administration fees, and penalties associated
with leakage.
To determine how plans inform participants about leakage, we
interviewed 26 plan administrators that represented an estimated 80
percent of 401(k) participants and 65 percent of 401(k) plan assets. As
part of these efforts, we analyzed documents related to leakage from
401(k) accounts and conducted 10 site visits during which we
interviewed representatives, reviewed relevant documentation, and
toured a participant call center. We also reviewed selected 401(k) plan
sponsor and administrator Web sites, and current pension law and
regulations. Appendix II provides a list of the 401(k) plan
administrators that we contacted.
To identify what is known about how various policy options may affect
the incidence of leakage, we identified provisions in current law,
regulations, and legislative proposals to identify policy options that
are likely to affect leakage. We then interviewed selected industry and
academic experts to determine how these provisions may affect leakage.
We analyzed their responses and identified the provisions that these
experts said were likely to affect leakage. We then developed model
scenarios based on the factors that experts identified, to illustrate
the effect that certain provisions may have on the accumulation of a
participant's retirement savings.
We conducted this performance audit from August 2008 to August 2009 in
accordance with generally accepted government auditing standards. Those
standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe that
the evidence obtained provides a reasonable basis for our findings and
conclusions based on our audit objectives. We determined that the data
that we analyzed were sufficiently reliable for the purposes of this
report. Appendix I of this report contains a detailed description of
the methodology used in this review and its limitations.
Background:
Private-sector pension plans are classified either as defined benefit
or as defined contribution plans. Defined benefit plans generally offer
a fixed level of monthly retirement income based upon a participant's
salary, years of service, and age at retirement, regardless of how the
plan's investments perform. In contrast, defined contribution plans,
such as 401(k) plans, benefit levels depend on the contributions made
to the plan and the performance of the investments in individual
accounts, which may fluctuate in value. Named after section 401(k) of
the Internal Revenue Code, traditional 401(k) plans allow workers to
save for retirement by diverting a portion of their pretax income into
an investment account that can grow tax-free and be withdrawn without
penalty after age 59½.[Footnote 4] Employers and employees may make
pretax contributions, up to certain limits, to individual participant
accounts. In 2009, participants may contribute up to $16,500 per year.
The 401(k) account balance is a function of both the contributions made
to the accounts over a career as well as the investment performance of
the account. As such, the declines in the markets can have a stark
effect on retirement savings, as happened in 2007 and 2008 when the
financial markets declined.
About one-half of all U.S. workers participate in some form of employer-
sponsored retirement plan. Participation in 401(k) plans rose steadily
from fewer than 8 million participants in the mid-1980s to over 70
million participants in 2006--the most recent year for which data were
available. The assets in 401(k) plans also increased significantly over
the same time period, from less than $100 billion to over $3 trillion.
[Footnote 5]
Current law limits participant access to their retirement savings in
their employer-sponsored retirement plans so that the favorable tax
treatment for retirement savings is limited to savings that are, in
fact, used to provide retirement income. Only under certain
circumstances do federal regulations allow 401(k) plan sponsors to
provide participants with access to their tax-deferred retirement
savings before retirement. IRS, within the Department of the Treasury,
and Labor's Employee Benefits Security Administration (EBSA) are
primarily responsible for enforcing laws that govern defined
contribution plans. IRS interprets and enforces provisions of the
Internal Revenue Code that apply to tax-qualified pension plans. EBSA
enforces the Employee Retirement Income Security Act (ERISA) reporting
and disclosure provisions and fiduciary responsibility standards,
which, among other things, concern the type and extent of information
provided to plan participants.
Plan sponsors have considerable latitude within the regulatory
guidelines to choose whether to provide this access in the form of a
participant loan, a hardship withdrawal, or a lump-sum distribution
when the participant separates from an employer. Plans may allow
participants to take loans, but may place limitations on the amounts,
purpose, or number of loans available. Plans may also allow
participants who can demonstrate that they are facing a hardship to
take hardship withdrawals. In addition, when separating from their
employer, participants may elect to receive a lump-sum distribution of
their account balance, or "cash out," rather than to preserve the tax-
deferred status of their accounts by rolling over their account into
another qualified plan or IRA. Table 1 provides a summary of the
provisions related to leakage from 401(k) plans.
Table 1: Provisions Related to 401(k) Leakage:
Provision: Employee Retirement Income Security Act of 1974;
Requirements: Requires plan administrators to furnish participants with
a summary plan description to ensure that all participants and
beneficiaries in participant-directed individual account plans have the
information relating to their benefits and rights under their plans;
Cashouts: [Check];
Hardship withdrawals: [Check];
Loans: [Check].
Provision: Revenue Act of 1978;
Requirements: Provides for a cash or deferred arrangement under section
401(k) of the Internal Revenue Code;
Cashouts: [Check];
Hardship withdrawals: [Check];
Loans: [Check].
Provision: Internal Revenue Code of 1986;
Requirements: Levies a 10 percent penalty for early withdrawals from
qualified retirement accounts except for instances involving death,
disability, severance from service, plan termination, or the attainment
of age 59½;
Cashouts: [Check];
Hardship withdrawals: [Check];
Loans: [Check].
Provision: Internal Revenue Code of 1986;
Requirements: Sets the maximum amount that the plan can permit as a
loan as (1) the greater of $10,000 or 50 percent of a participant's
vested account balance or (2) $50,000, whichever is less;
Cashouts: [Empty];
Hardship withdrawals: [Empty];
Loans: [Check].
Provision: Internal Revenue Code of 1986;
Requirements: Provides that a participant's elective contributions to a
401(k) plan may not be distributed prior to the occurrence of certain
events, such as the employee's separation from service or a hardship;
Cashouts: [Check];
Hardship withdrawals: [Check];
Loans: [Empty].
Provision: Internal Revenue Code of 1986;
Requirements: Provides that plan administrators may not cash out an
account balance that exceeds $5,000 without the consent of the
participant;
Cashouts: [Check];
Hardship withdrawals: [Empty];
Loans: [Empty].
Provision: Internal Revenue Code of 1986;
Requirements: Prohibits a hardship withdrawal from being rolled over
into an IRA or other qualified plan;
Cashouts: [Empty];
Hardship withdrawals: [Check];
Loans: [Empty].
Provision: Internal Revenue Code of 1986;
Requirements: Provides exceptions for paying the 10 percent penalty on
early withdrawals from qualified retirement plans;
Cashouts: [Check];
Hardship withdrawals: [Empty];
Loans: [Empty].
Provision: Internal Revenue Code of 1986;
Requirements: Requires plan administrators to provide a notice to a
participant of his or her right, if any, to defer receipt of an
immediately distributable benefit;
Cashouts: [Check];
Hardship withdrawals: [Empty];
Loans: [Empty].
Provision: Taxpayer Relief Act of 1997;
Requirements: Allows for distributions from certain plans to be used
without penalty to purchase first homes;
Cashouts: [Empty];
Hardship withdrawals: [Check];
Loans: [Empty].
Provision: Economic Growth and Tax Relief Reconciliation Act of 2001;
Requirements: Reduces elective contribution prohibition period
following a hardship withdrawal, from 12 months to 6 months;
Cashouts: [Empty];
Hardship withdrawals: [Check];
Loans: [Empty].
Provision: Economic Growth and Tax Relief Reconciliation Act of 2001;
Requirements: Requires automatic rollover of certain mandatory
distributions unless a participant opts out and reduces the cap to
$1,000 for involuntary cashouts at job separation;
Cashouts: [Check];
Hardship withdrawals: [Empty];
Loans: [Empty].
Provision: Pension Protection Act of 2006;
Requirements: Permits hardship withdrawal distributions for expenses
relating to medical, tuition, and funeral expenses for a "primary
beneficiary";
Cashouts: [Empty];
Hardship withdrawals: [Check];
Loans: [Empty].
Provision: Pension Protection Act of 2006;
Requirements: Requires plan sponsors to provide a notice to
participants of the consequences of the failure to defer their account
balance at job separation;
Cashouts: [Check];
Hardship withdrawals: [Empty];
Loans: [Empty].
Source: GAO analysis of relevant laws.
[End of table]
Plan sponsors may, but are not required to, offer loan and hardship
withdrawal provisions to participants. In providing these options,
plans offer participants a certain flexibility and short-term financial
relief that may improve a participant's overall long-term financial
standing if the distributions are used, for example, to pay off high-
interest credit card debt, purchase a primary residence, or support a
college education. Furthermore, as we reported in October 1997, the
availability of loan provisions is associated with encouraging workers
to join their employer-sponsored 401(k) plans when they otherwise might
not, resulting in higher overall participation and contribution
rates.[Footnote 6] Unlike other forms of leakage, participant loans,
which are paid back to the plan with interest, become leakage only if
they are not repaid.
Early access to retirement savings may also burden participants with
short-term costs and long-term consequences. In the short term,
participants who take a distribution before reaching age 59½ generally
pay a 10 percent early withdrawal penalty and income taxes on the
distribution amount, and may face other restrictions and fees, such as
loan origination fees. In the longer term, this leakage may reduce the
amounts that participants can save prior to retirement by permanently
removing assets from their accounts and forgoing the accumulation of
savings realized through compounding.
Rules Affecting Early Distributions from Retirement Plans:
The tax-deferred contributions in participants' 401(k) plans can only
be distributed upon the occurrence of certain events. As shown in table
2, each of the principal forms of 401(k) leakage that we identified is
subject to a number of specific rules. For example, to discourage the
use of pension funds for purposes other than retirement, the law
imposes an additional 10 percent tax on certain early distributions
made from qualified retirement plans, such as a 401(k) plan, before a
participant reaches age 59½. As regular income distributions, these
early distributions are subject to federal and state income tax
withholding and taxed at the marginal income tax rate.[Footnote 7] Some
early distributions may not be taxable if they are rolled over into an
IRA or another qualified retirement account. Certain other
distributions have been exempted from the additional tax.[Footnote 8]
Table 2: Comparison of the Rules Governing the Three Principal Forms of
401(k) Leakage:
Leakage type: Cashouts;
Amount restrictions: Up to 100 percent of account balance;
Allowable purpose: Participants may use the distribution for any
purpose;
Documentation requirements: Participant with account balances over
$5,000 must affirm their decision to take a lump-sum distribution at
job separation;
Associated costs: Participants are required to pay federal and state
income taxes on the distribution amount. Participants under age 59½ may
be subject to 10 percent early withdrawal penalty. Participants are
subject to 20 percent employer withholding;
Other restrictions: Available to participants only when separating from
their employer. Generally, a plan administrator must obtain
participants' consent before making a distribution from an account
balance that exceeds $5,000. Employers may cash out separating
participants' account balances under $5,000 from their plan without the
participants' consent. They may compel cashouts of balances under
$1,000, but are required to roll over account balances of between
$1,000 and $5,000 into an IRA.
Leakage type: Hardship withdrawals;
Amount restrictions: Limited to the amount of the employee's elective
contributions, and generally do not include any income earned on the
deferred amounts;
Allowable purpose: Hardship withdrawal distributions must be made on
account of an immediate and heavy financial need. The financial need
may be immediate and heavy, even if the event was reasonably
foreseeable or voluntarily incurred. A distribution is deemed to be on
account of an immediate and heavy financial need of the employee if the
distribution is for the following:
* expenses for medical care previously incurred by the employee, the
employee's spouse, or any dependents of the employee or necessary for
these persons to obtain medical care;
* costs directly related to the purchase of a principal residence for
the employee (excluding mortgage payments);
* payment of tuition, related educational fees, and room and board
expenses, for the next 12 months of postsecondary education for the
employee or the employee's spouse, children, or dependents;
* payments necessary to prevent the eviction of the employee from the
employee's principal residence or foreclosure on the mortgage on that
residence;
* funeral expenses; or;
* certain expenses relating to the repair of damage to the employee's
principal residence;
Documentation requirements: Participants must provide documentation of
their hardship;
Associated costs: Federal and state income taxes. Participants under
age 59½ may be subject to 10 percent early withdrawal penalty.
Participants are subject to 20 percent employer withholding;
Other restrictions: A plan may only allow hardship withdrawals if
participants have obtained all other currently available distributions
and loans under the plan and all other plans maintained by the
employer. Participants face a 6-month suspension of contributions to
their accounts following hardship withdrawal. Participants may not roll
over any part of their hardship withdrawal into an IRA or other
qualified plan.
Leakage type: Loans;
Amount restrictions: Up to 50 percent of a participant's vested account
balance or $50,000, whichever is less;
Allowable purpose: General purpose. Purchase of a primary residence;
Documentation requirements: None for general purpose loans. Evidence of
imminent home purchase generally required for principal residence
loans;
Associated costs: Must pay amount back to account, with interest. Loans
that are not repaid are treated as loan defaults and the outstanding
loan balance is removed from the plan and sent to the participant as a
taxable distribution of income;
Other restrictions: Loan repayments are not considered plan
contributions. Participants must repay loans in substantially equal
payments that include principal and interest. The repayment period is
within 5 years for general purpose loans, and is longer for primary
residence loans.
Source: GAO analysis of laws and regulations.
[End of table]
Participants tapping into their 401(k) account follow different rules
and procedures to gain access to their money, depending on whether they
take a loan, hardship withdrawal, or cashout. Figure 1 describes the
process that a participant must generally follow to withdraw money
using one of these options.
Figure 1: Options Available to Participants to Withdraw Money from a
401(k) Account before Retirement:
[Refer to PDF for image: illustration]
Option 1: Loan;
Most plans allow participants to take a loan for any reason.
* The participant contacts the plan via a call center or Web site;
* The participant then fills out an application online or on paper and
sends it to the plan;
* 401(k) plan: The plan sends a check with tax notices to the
participant within 2 days;
* The participant begins repayment of the loan via payroll deduction.
Option 2: Hardship withdrawal;
As defined by the IRS, the participant must have an immediate and heavy
financial need to qualify and no other resources to fill the need.
* The participant contacts the plan by telephone;
* 401(k) plan: The plan sends the participant a hardship withdrawal
form;
* The participant fills out a paper application and mails it to the
plan;
* 401(k) plan: The plan reviews the application and approves or denies
it;
* If approved, the participant receives a check with tax notices in the
mail.
Option 3: Cashout;
Participants leaving their jobs have the option of cashing out their
account, in part or in full.
* 401(k) plan: The plan sends a termination packet informing the
participant of options for managing 401(k) account balance;
* The participant receives termination packet from the plan and decides
to take a lump-sum distribution;
* The participant receives a lump-sum distribution from the plan and
chooses not to roll it over into an IRA or qualified plan.
Sources: GAO (analysis); Art Explosion (images).
[End of figure]
Leakage Has Remained Relatively Steady, with Cashouts Having the
Greatest Impact on Retirement Savings:
Leakage Has Remained Relatively Steady, Even in the Poor Economy:
Our estimates--based on SIPP data collected in 1998, 2003, and 2006--
found no statistically significant differences in the overall incidence
of leakage from 401(k) accounts in the data from the three SIPP panels
that we analyzed, with approximately 15 percent of participants between
ages 15 and 60 initiating at least one form of leakage.[Footnote 9] As
shown in figure 2, we estimated that the percentage of participants
experiencing each leakage type remained steady across the 3 years, with
more participants borrowing money from their plans in the form of a
loan than taking a cashout or hardship withdrawal.
Figure 2: Estimated Percentage of 401(k) Participants Ages 15 to 60
Reporting Leakage, by Leakage Type:
[Refer to PDF for image: vertical bar graph]
Leakage type: Any form;
1998: 16%;
2003: 17%;
2006: 14%.
Leakage type: Cashouts;
1998: 7%;
2003: 6%;
2006: 5%.
Leakage type: Hardship withdrawals;
1998: 4%;
2003: 3%;
2006: 3%.
Leakage type: Loans;
1998: 8%;
2003: 10%;
2006: 8%.
Source: GAO analysis of SIPP data.
Note: The SIPP wave 7 Pension and Retirement Topical Module was
collected 2 years after the start of the 1996, 2001, and 2004 SIPP
panels, respectively. The amounts for the individual forms of leakage
do not equal the total for the Any form category due to rounding of
estimates to the nearest percentage. The 95 percent confidence
intervals for the estimates shown are as follows. Any form: 1998 (15.4,
17.1), 2003 (15.7, 17.7), 2006 (13.5, 14.9). Cashouts: 1998 (6.1, 7.2),
2003 (5.5, 6.8), 2006 (4.7, 5.6). Hardship withdrawals: 1998 (3.5,
4.3), 2003 (2.6, 3.6), 2006 (2.8, 3.6). Loans: 1998 (7.5, 8.7), 2003
(9.1, 10.7), 2006 (7.5, 8.6).
[End of figure]
Our analysis of SIPP data found significant differences in the amounts
of leakage, by type, that participants reported taking from their
401(k) plans, with the total cashout amounts being significantly higher
than the total amounts of either hardship withdrawals or loans. As
shown in figure 3, we estimated that the amount of leakage reported in
2006 was approximately $108 billion, with cashouts comprising the bulk
of that amount.[Footnote 10]
Figure 3: Estimated Total Amounts of Leakage Reported by 401(k)
Participants, Ages 15 to 60, by Leakage Type:
[Refer to PDF for image: vertical bar graph]
Leakage type: Cashouts;
1998: $72 billion;
2003: $79 billion;
2006: $74 billion.
Leakage type: Hardship withdrawals;
1998: $9 billion;
2003: $5 billion;
2006: $9 billion.
Leakage type: Loans;
1998: $22 billion;
2003: $28 billion;
2006: $25 billion.
Source: GAO analysis of SIPP data.
Note: The SIPP wave 7 Pension and Retirement Topical Module was
collected 2 years after the start of the 1996, 2001, and 2004 SIPP
panels, respectively. Dollar amounts have been adjusted for inflation
and are reported in constant calendar year 2008 dollars. The 95 percent
confidence intervals are expressed in billions of dollars. The 95
percent confidence intervals for the estimates shown are as follows.
Cashouts: 1998 (65.2, 79.8), 2003 (68.0, 89.6), 2006 (66.5, 81.8).
Hardship withdrawals: 1998 (6.9, 10.2), 2003 (3.8, 6.5), 2006 (7.4,
10.7). Loans: 1998 (19.7, 24.8), 2003 (24.6, 30.5), 2006 (22.2, 27.4).
[End of figure]
The median amounts of leakage also remained steady in the 3 years of
SIPP data that we analyzed. According to our estimates, the median
cashout amount was significantly higher than the median loan amount.
(See figure 4.)
Figure 4: Estimated Median Amounts of Leakage Reported by 401(k)
Participants, Ages 15 to 60, by Leakage Type (Dollars in thousands):
[Refer to PDF for image: vertical bar graph]
Leakage type: Cashouts;
1998: $3,861;
2003: $3,470;
2006: $4,166.
Leakage type: Hardship withdrawals;
1998: $3,461;
2003: $3,060;
2006: $3,123.
Leakage type: Loans;
1998: $3,240;
2003: $2,574;
2006: $2,126.
Source: GAO analysis of SIPP data.
Note: The SIPP wave 7 Pension and Retirement Topical Module was
collected 2 years after the start of the 1996, 2001, and 2004 SIPP
panels, respectively. Dollar amounts have been adjusted for inflation
and are reported in constant calendar year 2008 dollars. The 95 percent
confidence intervals are expressed in thousands of dollars. The 95
percent confidence intervals for estimates are as follows. Cashouts:
1998 (3.8, 4.0), 2003 (3.9, 4.7), 2006 (4.3, 5.7). Hardship
Withdrawals: 1998 (2.6, 4.1), 2003 (2.3, 4.2), 2006 (2.6, 4.2). Loans:
1998 (2.8, 4.0), 2003 (2.4, 3.6), 2006 (2.0, 2.8).
[End of figure]
The overall incidence and amounts of leakage from loans and hardship
withdrawals also remained steady through 2008, according to data that
we obtained from selected major 401(k) administrators.[Footnote 11]
While these data were not nationally representative, they covered a
wide spectrum of 401(k) plans, participants, and assets. As shown in
table 3, the overall incidence and average amounts of leakage changed
little, if at all, from 2005 through 2008. Two administrators also told
us that they had seen little change in the number of hardship
withdrawals and loans in the first quarter of 2009.
Table 3: Recent Trends in 401(k) Leakage as Reported by Selected Major
401(k) Plan Administrators, 2005 through 2008:
Leakage form: Loans;
Administrator: #1;
2005: Average amount: $8,030; 20.0%;
2006: Average amount: $8,300; 20.0%;
2007: Average amount: $8,590; 20.0%;
20008: Average amount: $8,710; 19.0%.
Leakage form: Loans;
Administrator: #2;
2005: Average amount: $8,039; 18.0%;
2006: Average amount: $8,260; 17.0%;
2007: Average amount: $8,571; 16.0%;
2008: Average amount: $8,624; 16.0%.
Leakage form: Loans;
Administrator: #3;
2005: Average amount: $6,091; 18.0%;
2006: Average amount: $7,246; 18.0%;
2007: Average amount: $8,228; 18.0%;
2008: Average amount: $8,657; 18.0%.
Leakage form: Hardship withdrawals;
Administrator: #1;
2005: Average amount: $6,070; 1.4%;
2006: Average amount: $6,250; 1.5%;
2007: Average amount: $6,160; 1.6%;
2008: Average amount: $5,960; 1.8%.
Leakage form: Hardship withdrawals;
Administrator: #2;
2005: Average amount: $6,113; [Empty];
2006: Average amount: $6,458; 1.5%;
2007: Average amount: $5,305; 1.6%;
2008: Average amount: $5,821; 1.7%.
Leakage form: Hardship withdrawals;
Administrator: Administrator: #3;
2005: Average amount: $7,240; 2.1%;
2006: Average amount: $7,555; 2.3%:
2007: Average amount: $8,038; 2.3%:
2008: Average amount: $8,444; 2.4%.
Source: GAO analysis of data obtained from selected major 401(k)
administrators.
Note: These data from selected 401(k) administrators are not nationally
representative and may not reflect the estimates provided of nationally
representative SIPP data. Not all of the administrators we contacted
provided comparable data on the incidence and amount of cashouts taken
by 401(k) participants before turning age 60.
[End of table]
Taking a cashout, hardship withdrawal, or loan can come with costs that
can amplify the detrimental effect that leakage can have on a
participant's retirement savings. For example, early distributions from
a 401(k) account, whether in the form of a cashout, hardship
withdrawal, or defaulted loan, may be subject to a 10 percent tax
penalty that must be paid in addition to the amount of the
distribution. In addition, some plans require participants who take a
loan to pay an additional loan origination fee or periodic loan
maintenance fees over the course of the loan repayment period.
Participants taking hardship withdrawals are subject to the 10 percent
penalty and must eventually pay federal and state income taxes on the
hardship withdrawal amount. In addition, the requirement that
participants suspend all contributions to their plans for 6 months
following the hardship withdrawal not only prevents participants from
continuing to make contributions but also precludes them from obtaining
any employer matching contribution. The additional costs associated
with cashouts, hardship withdrawal, and defaulted loans can compound
permanent losses of retirement income by reducing a participant's
balance and precluding these amounts from compounding in the account
over time.
While the estimated amount of 401(k) leakage is in the billions of
dollars, it represents a relatively small proportion of the aggregate
value of assets in 401(k) plans. As shown in figure 5, in 2006, leakage
resulted in marginal losses in retirement savings in aggregate. Yet, at
the level of the individual participant, leakage can create
considerable displacement of retirement savings.
Figure 5: Illustration of 401(k) Leakage as a Proportion of Overall
401(k) Plan Assets in 2006:
[Refer to PDF for image: illustration]
401(k) assets: $2.7 trillion;
* Participant contributions;
* Employer matching contributions.
Cashouts at job change: $74 billion;
Loan defaults: $561 million;
Hardship withdrawals: $9 billion.
Sources: GAO analysis of Department of Labor and Census Bureau data;
Art Explosion (images).
[End of figure]
Cashouts Can Have the Greatest Impact on Retirement Savings:
Cashouts at job separation can have the greatest impact of the
principal forms of leakage on an individual participant's savings,
according to the results of our analysis. We simulated a range of
leakage scenarios that took into account the age, earnings, and job
tenure of participants as well as a range of leakage amounts. We found
that cashouts of any amount at job separation--whether taken in part or
in full--can have a greater effect on a participant's account balance
at age 65 than comparable amounts taken in the form of a hardship
withdrawal or loan. As shown in table 4, cashouts resulted in a greater
proportional loss of retirement savings among low-wage earners,
especially those who took a partial cashout earlier in their working
careers.
Table 4: Illustration of the Effect of a $5,000 Loan, Hardship
Withdrawal, or Cashout on a Participant's 401(k) Account, by Age and
Wage Level:
Age: 35;
Wage level: Low;
Average annual earnings: $16,444;
No leakage: Account balance at age 65: $264,624; 100.0%;
Loan: ($5,000); Account balance at age 65: $264,075; 99.8%;
Hardship withdrawal: ($5,000); Account balance at age 65: $233,607;
88.3%;
Partial cashout: ($5,000); Account balance at age 65: $230,035; 86.9%.
Age: 35;
Wage level: Medium;
Average annual earnings: $36,546;
No leakage: Account balance at age 65: $588,049; 100.0%;
Loan: ($5,000); Account balance at age 65: $587,500; 99.9%;
Hardship withdrawal: ($5,000); Account balance at age 65: $552,597;
94.0%;
Partial cashout: ($5,000); Account balance at age 65: $544,658; 92.6%.
Age: 35;
Wage level: High;
Average annual earnings: $58,497;
No leakage: Account balance at age 65: $940,839; 100.0%;
Loan: ($5,000); Account balance at age 65: $940,290; 99.9%;
Hardship withdrawal: ($5,000); Account balance at age 65: $900,506;
95.7%;
Partial cashout: ($5,000); Account balance at age 65: $887,836; 94.4%.
Age: 45;
Wage level: Low;
Average annual earnings: $26,383;
No leakage: Account balance at age 65: $264,624; 100.0%;
Loan: ($5,000); Account balance at age 65: $264,331; 99.9%;
Hardship withdrawal: ($5,000); Account balance at age 65: $243,873;
92.2%;
Partial cashout: ($5,000); Account balance at age 65: $240,341; 90.8%.
Age: 45;
Wage level: Medium;
Average annual earnings: $58,606;
No leakage: Account balance at age 65: $588,049; 100.0%;
Loan: ($5,000); Account balance at age 65: $587,756; 100.0%;
Hardship withdrawal: ($5,000); Account balance at age 65: $562,860;
95.7%;
Partial cashout: ($5,000); Account balance at age 65: $555,013; 94.4%.
Age: 45;
Wage level: High;
Average annual earnings: $93,802;
No leakage: Account balance at age 65: $940,839; 100.0%;
Loan: ($5,000); Account balance at age 65: $940,546; 100.0%;
Hardship withdrawal: ($5,000); Account balance at age 65: $910,802;
96.8%;
Partial cashout: ($5,000); Account balance at age 65: $898,243; 95.5%.
Age: 55;
Wage level: Low;
Average annual earnings: $36,105;
No leakage: Account balance at age 65: $264,624; 100.0%;
Loan: ($5,000); Account balance at age 65: $264,447; 99.9%;
Hardship withdrawal: ($5,000); Account balance at age 65: $252,090;
95.3%;
Partial cashout: ($5,000); Account balance at age 65: $249,347; 94.2%.
Age: 55;
Wage level: Medium;
Average annual earnings: $80,252;
No leakage: Account balance at age 65: $588,049; 100.0%;
Loan: ($5,000); Account balance at age 65: $587,873; 100.0%;
Hardship withdrawal: ($5,000); Account balance at age 65: $572,064;
97.3%;
Partial cashout: ($5,000); Account balance at age 65: $565,968; 96.2%.
Age: 55;
Wage level: High;
Average annual earnings: $128,418;
No leakage: Account balance at age 65: $940,839; 100.0%;
Loan: ($5,000); Account balance at age 65: $940,663; 100.0%;
Hardship withdrawal: ($5,000); Account balance at age 65: $921,090;
97.9%:
Partial cashout: ($5,000); Account balance at age 65: $911,334; 96.9%.
Source: GAO.
Note: These illustrations are based on an individual who is born at the
beginning of 1970, begins participating in a 401(k) plan at age 21 in
1991, and retires at age 65 in 2035. We adopt the intermediate interest
and rate-of-return assumptions as reported in past and projected in
Social Security's most recent Old-Age, Survivors, and Disability
Insurance (OASDI) Trustees' Report and for low, medium, and high annual
earnings. Employee contributions are 6 percent and receive a 3 percent
employer matching contribution. We assume that loans are taken out at
the beginning of the year that the individual reaches the age
indicated, loans incur a $100 fee deducted from the account balance,
and loans are repaid in 5 years at a fixed interest rate equal to the
rate of return at the time that the loan is made. Participants who
reduce their rate of contributions while making loan payments will
experience a greater reduction in their account balance at age 65. We
assume that hardship withdrawals are taken out at the beginning of the
year that the individual reaches the age indicated and follow the
rules. We assume that partial cashouts are taken out at the beginning
of the year that the individual reaches the age indicated, partial
cashouts incur the 10 percent early withdrawal penalty, and the
individual does not resume elective or employer matching contributions
to a 401(k) account for 12 months following the distribution, to allow
for any delay in the resumption of employment or a waiting period
before beginning to participate in a new employer's 401(k) plan, or
both. Individuals who take a partial cashout and resume contributions
to a 401(k) plan prior to the end of a 12-month period would under
certain circumstances experience less leakage from their account
balance at age 65. For example, a participant taking a cashout at job
change who experienced no interruption in contributions would have a
higher account balance at age 65 than if he or she had taken a hardship
withdrawal for the same amount.
[End of table]
Participants who voluntarily cashed out their entire 401(k) account
balance at job separation experienced the largest reductions in the
amount of retirement savings that accumulate over their working
careers. As shown in table 5, unlike partial cashouts, which leave some
assets in the plan to grow over time, total cashouts can significantly
reduce a participant's retirement savings, even when the participant
experiences no interruption of 401(k) contributions. Cashouts can be
especially damaging if taken later in a career when a participant has
less time to recover the losses. For example, table 5 also shows that
if a participant were to cash out their plan at age 35, their account
balance at age 65 would be $404,431, or $183,618 less than had they
left the money in their account.
Table 5: Illustration of the Effect of Cashing Out the Entire 401(k)
Account Balance at Job Separation, for Medium-Income Earners:
Age at which cashout occurs: 25;
401(k) account balance at age 65: With no leakage: $588,049;
401(k) account balance at age 65: After total cashout: $551,256;
Total cashout from 401(k) plan[A]: $4,214;
Decrease in account balance: Amount: $36,794;
Decrease in account balance: Percent: 6.
Age at which cashout occurs: 30;
401(k) account balance at age 65: With no leakage: $588,049;
401(k) account balance at age 65: After total cashout: $482,675;
Total cashout from 401(k) plan[A]: $16,538;
Decrease in account balance: Amount: $105,375;
Decrease in account balance: Percent: 18.
Age at which cashout occurs: 35;
401(k) account balance at age 65: With no leakage: $588,049;
401(k) account balance at age 65: After total cashout: $404,431;
Total cashout from 401(k) plan[A]: $36,874;
Decrease in account balance: Amount: $183,618;
Decrease in account balance: Percent: 31.
Age at which cashout occurs: 40;
401(k) account balance at age 65: With no leakage: $588,049;
401(k) account balance at age 65: After total cashout: $323,036;
Total cashout from 401(k) plan[A]: $65,240;
Decrease in account balance: Amount: $265,013;
Decrease in account balance: Percent: 45.
Age at which cashout occurs: 45;
401(k) account balance at age 65: With no leakage: $588,049;
401(k) account balance at age 65: After total cashout: $241,382;
Total cashout from 401(k) plan[A]: $111,392;
Decrease in account balance: Amount: $346,667;
Decrease in account balance: Percent: 59.
Age at which cashout occurs: 50;
401(k) account balance at age 65: With no leakage: $588,049;
401(k) account balance at age 65: After total cashout: $164,174;
Total cashout from 401(k) plan[A]: $180,632;
Decrease in account balance: Amount: $423,876;
Decrease in account balance: Percent: 72.
Age at which cashout occurs: 55;
401(k) account balance at age 65: With no leakage: $588,049;
401(k) account balance at age 65: After total cashout: $95,329;
Total cashout from 401(k) plan[A]: $279,022;
Decrease in account balance: Amount: $492,720;
Decrease in account balance: Percent: 84.
Source: GAO.
Note: These illustrations are based on an individual who is born at the
beginning of 1970, begins participating in a 401(k) plan at age 21 in
1991, and retires at age 65 in 2035. We adopt the intermediate interest
and rate-of-return assumptions as reported in past and projected in
Social Security's 2009 OASDI Trustees' Report and use their medium
level for annual earnings. Employee contributions are 6 percent and
receive a 3 percent employer matching contribution. These full cashouts
incur a 10 percent tax penalty for early withdrawal, which is included
in the amount cashed out from the 401(k) plan, and are taken out at the
beginning of the year that the individual reaches the age indicated. We
assume that the individual resumes employment immediately following the
job separation and continues his or her own and matching contributions
at the same level without interruption. Any interruption in 401(k)
contributions--such as unemployment or a waiting period before an
individual can participate--would further reduce the 401(k) account
balance at age 65.
[A] This amount represents the amount that an participant earning a
medium income could have accumulated by the age in which the cashout
occurred, assuming a steady 6 percent elective participant contribution
and a 3 percent employer matching contribution.
[End of table]
Hardship Withdrawals Can Result in Large Reductions in Retirement
Savings:
Participants who initiated hardship withdrawals also experienced large
reductions in their retirement savings over their careers. While
slightly less than the amounts lost due to cashouts, hardship
withdrawals can result in permanent loss of retirement income and may
affect participants at a time when they face greater difficulty in
recouping the losses. In our analysis of various leakage scenarios, we
found that among all age and income levels, hardship withdrawals had
the greatest impact on low-income and younger participants. For
example, our simulation showed that a low-earning 35-year-old
participant taking a $5,000 hardship withdrawal would forgo 12 percent
in retirement savings resulting from the hardship, whereas a high-
earning participant of the same age would forgo less than 5 percent due
to higher contribution amounts. Larger hardship withdrawal amounts
taken earlier in a participant's career had the greatest proportional
impact on participants who earned lower incomes.
Loans Have the Least Damaging Effect on Retirement Savings:
Of the three principal forms of leakage that experts identified, loans
paid back to the plan in regular installments are the least damaging,
because participants are able to recover most of their losses,
regardless of their age or earnings level. While the overall amount of
participant loans has increased since 1996, as shown in figure 6, this
rise roughly paced the overall growth in the number of 401(k)
participants.
Figure 6: Outstanding Participant Loan Balances and Number of Active
401(k) Participants, 1996 through 2006:
[Refer to PDF for image: combination vertical bar and line graph]
Year: 1996;
Outstanding loan balances: $26.9
Active participants: 28.5 million.
Year: 1997;
Outstanding loan balances: $30.8
Active participants: 32.3 million.
Year: 1998;
Outstanding loan balances: $32.8
Active participants: 35.9 million.
Year: 1999;
Outstanding loan balances: $34.8
Active participants: 37.8 million.
Year: 2000;
Outstanding loan balances: $35.4
Active participants: 39.2 million.
Year: 2001;
Outstanding loan balances: $39
Active participants: 41.3 million.
Year: 2002;
Outstanding loan balances: $37.8
Active participants: 42.6 million.
Year: 2003;
Outstanding loan balances: $40.4
Active participants: 43 million.
Year: 2004;
Outstanding loan balances: $39.4
Active participants: 43.4 million.
Year: 2005;
Outstanding loan balances: $44.6
Active participants: 53.6 million.
Year: 2006;
Outstanding loan balances: $47.3
Active participants: 57.3 million.
Source: GAO analysis of Department of Labor‘s Form 5500 Annual Reports.
Note: Dollar amounts are reported in constant 2008 dollars.
[End of figure]
Experts told us that participant loans constitute limited leakage only
when they are not paid back to the plan, even though there may be
costs, such as paying loan fees, which could reduce participant
balances. Like cashouts, the outstanding balance of a defaulted loan is
distributed to the participant as income and is subject to the 10
percent penalty and various taxes. According to the most recent data
available from Labor, the amount of loan defaults from 401(k) plans
ranged from a low of $359 million to a high of $666 million in the
period of 1999 through 2006. (See figure 7.)
Figure 7: Loan Default Amounts Reported by 401(k) Plans, 1999 through
2006:
[Refer to PDF for image: vertical bar graph]
Year: 1999;
Loan default amounts: $359 million.
Year: 2000;
Loan default amounts: $468 million.
Year: 2001;
Loan default amounts: $517 million.
Year: 2002;
Loan default amounts: $666 million.
Year: 2003;
Loan default amounts: $463 million.
Year: 2004;
Loan default amounts: $500 million.
Year: 2005;
Loan default amounts: $482 million.
Year: 2006;
Loan default amounts: $561 million.
Source: GAO analysis of Department of Labor‘s Form 5500 Annual Reports.
Note: Dollar amounts are reported in constant 2008 dollars.
[End of figure]
Plans have some security against default on a participant loan because
loan repayments are automatically deducted from a participant's
paycheck as long as the participant is employed. However, under current
rules, participants who separate from their employer and have an
outstanding loan balance generally must repay the loan balance in full
shortly after their separation.[Footnote 12] For participants who face
involuntary job separation, such as a layoff, the requirement to repay
the loan in full may create a burden. Like cashouts, the larger the
loan balance when the participant defaults, the greater the impact the
loan default can have on a participant's retirement savings. Table 6
illustrates the effect of a loan default on a participant's retirement
savings at age 65.
Table 6: Illustration of the Effect of Defaulting on a $5,000 Loan
after 1 Year of Repayment, for a Medium-Income 401(k) Participant:
Age when loan default occurs: 35;
401(k) account balance at age 65: If loan is repaid: $587,500;
401(k) account balance at age 65: If loan defaults after 1 year:
$566,121;
Decrease in account balance: Amount: $21,379;
Decrease in account balance: Percent: 4.
Age when loan default occurs: 45;
401(k) account balance at age 65: If loan is repaid: $587,756;
401(k) account balance at age 65: If loan defaults after 1 year:
$574,445;
Decrease in account balance: Amount: $13,311;
Decrease in account balance: Percent: 2.
Age when loan default occurs: 55;
401(k) account balance at age 65: If loan is repaid: $587,873;
401(k) account balance at age 65: If loan defaults after 1 year:
$580,330;
Decrease in account balance: Amount: $7,543;
Decrease in account balance: Percent: 1.
Source: GAO.
Note: These illustrations are based on an individual who is born at the
beginning of 1970, begins participating in a 401(k) plan at age 21 in
1991, and retires at age 65 in 2035. We adopt the intermediate interest
and rate-of-return assumptions as reported in past and projected in
Social Security's 2009 OASDI Trustees' Report and use their medium
level for annual earnings. Employee contributions are 6 percent and
receive a 3 percent employer matching contribution. Loans incur a $100
fee deducted from the account balance, are taken out at the beginning
of the year that the individual reaches the age indicated, and are
repaid for a year at a fixed interest rate equal to the rate of return
at the time the loan is made and then the borrower defaults on the
outstanding balance. This outstanding balance is treated as an early
withdrawal and incurs a 10 percent tax penalty for early withdrawal.
[End of table]
Loan defaults may affect participants differently, depending on whether
job separation is voluntary or involuntary. For example, loan defaults
can adversely affect participants who, after securing a loan from their
account, suddenly find themselves laid off by their employers. These
participants will typically be required to repay the amount of the loan
back to the plan in full within a short time frame. Participants who
cannot or do not repay their loan balance in full must generally pay
the 10 percent penalty and income taxes on the outstanding amount that
is distributed to them as income, resulting in a loss of retirement
savings.[Footnote 13]
Plans Used Various Means to Inform Participants about Withdrawal
Provisions, but Few Alerted Them to the Negative Long-term
Implications:
Plans Used Various Means to Inform Participants about Leakage
Provisions:
Federal law requires plans to provide several mandatory written
communications to participants that contain information on the various
provisions affecting cashouts, hardship withdrawals, and loans. As
shown in table 7, for each document, the law defines the type of
information to be included and the timing of the delivery.
Table 7: Mandatory Disclosures Provided to 401(k) Plan Participants:
Document: Summary plan description (SPD);
Information included: Plans must provide information to plan
participants about the plan, and how it operates, and must apprise
participants of their benefits, rights, and obligations under the plan.
The SPD would include the availability of loan, hardship withdrawal,
and cashout provisions; (29 C.F.R. § 2520.102-2 and § 2520.102-3);
Timing: Sent to participants within 90 days of becoming covered by the
plan. The SPD must be furnished every 5 years, if amended or otherwise
once every 10 years; (29 C.F.R. § 2520.104b-2).
Document: Summary of material modifications (SMM);
Information included: Plans must provide a new SPD or SMM whenever the
SPD is amended. The SMM must describe plan modifications and changes.
Distribution of an updated SPD fulfills this requirement. The SMM may
include any changes in the availability of loan, hardship withdrawal,
and cashout provisions; (29 C.F.R. § 2520.104b-3);
Timing: Provided no later than 210 days after the end of the plan year
in which the change is adopted.
Document: 402(f) special tax notice;
Information included: Plans must provide a tax notice to participants
at termination explaining the rollover rules, the special tax treatment
for lump-sum distributions, and the mandatory 20 percent withholding
rules. The notice may be sent via mail or e-mail. This notice is sent
to all terminating participants; (26 C.F.R. § 1.402(f)-1, Q/A-2; Q/A-
5);
Timing: Provided no more than 90 days (as much as 180 days for plan
years that begin after December 31, 2006) and no fewer than 30 days
before making an eligible rollover distribution.
Source: GAO analysis of law and regulations from the Internal Revenue
Service and the Department of Labor.
[End of table]
Plan officials we contacted told us that one way participants could
learn about their plans' loan and withdrawal provisions is through the
summary plan description (SPD). Some plan officials told us that they
developed reader-friendly highlights of the SPD to communicate the plan
procedures to participants. For example, the SPD highlights from one
plan explained the following provisions on one page: participant
eligibility, contribution amount, rollover contributions, the employer
match, vesting, the investment choices, loans, and withdrawals.
Officials that we contacted told us that the highlights documents are
kept intentionally vague out of concern that participants might rely on
these documents, rather than the actual SPD. However, one plan official
and one expert stated that the extent to which participants understand
the information and use it to make informed choices about their
accounts remains unknown.
Plans that we contacted provided participants with information on
leakage at three distinct points determined by federal requirements: at
enrollment, when a loan or hardship withdrawal is requested, and at job
termination. Some plans that we contacted provided participants with
information about loans and hardship withdrawals in the participant's
initial enrollment package. Other plans that we contacted provided
participants with information beyond federally required notices at the
participant's request. Another plan sent out a termination package when
a plan sponsor sent notification of a participant's termination date,
while another plan waited for the participant to contact the plan upon
job termination. According to some plan officials, participants inquire
about plan provisions when a triggering event occurs, such as when the
participants need access to money in their account or when they are
separating from their job. Participants, however, may request
information about withdrawing money from their accounts at any time.
Apart from meeting federal requirements, plans have varying levels of
involvement with participants, ranging from plans seeking to protect
participants from making poor decisions with respect to cashouts,
hardship withdrawals, or loans, to plans giving participants little
advice on how leakage would affect their retirement accounts. Some
plans we contacted provided participants with detailed information that
went beyond the legally mandated disclosures about the implications of
cashouts, hardship withdrawals, and loans. Some plan officials we
contacted stated that they gave no information to participants about
the effects of cashouts, hardship withdrawals, and loans on retirement
account balances to participants for fear of being perceived as
offering advice and potentially violating their fiduciary duty to the
plan. According to EBSA officials, providing investment advice is not a
per se violation of fiduciary duty. Other plan officials that we
contacted told us that while they wanted to make sure that participants
understood the impact of withdrawing money from their accounts, they
did not want to tell participants that they should not take a
distribution.
Some plans that we contacted also staffed call centers to answer
participants' questions about their accounts, which they said also
included topics related to the principal forms of leakage. Call center
representatives had immediate access to participant account
information, could inform participants about their range of options for
withdrawing money from their accounts, and could discuss the mandatory
federal disclosures with the participants. At one participant call
center, plan officials demonstrated how the representatives would
respond to a participant requesting information about acquiring a loan,
about a hardship withdrawal, or about the management of their account
balance at job termination. Some plan officials said that they trained
call center representatives to inform participants of the available
options, while other plans told us that they sought to dissuade
participants from taking a hardship withdrawal. One plan that we
contacted required participants to contact the call center at job
termination, so that the representative could counsel the participant
on the best option for that individual.
Plan officials told us that younger participants preferred to use the
plan Web sites to locate the information they needed. Some plans that
we contacted had plan documents available online, such as hardship
withdrawal applications and procedures, providing participants with
immediate access to information about the processes and impacts of
withdrawing money from their account. Plan officials told us that some
Web-based communications often provided the same information available
to plan participants in print, while other Web-based communications
were less comprehensive than the written information available to
participants. Some plans that we contacted also utilized plan Web sites
to notify participants of the amount of money available for a cashout,
hardship withdrawal, or loan. One plan also provided a 5-to 10-minute
online course outlining the impact of leakage on the participant's long-
term savings. Two plans that we contacted included information on
leakage in articles on plan Web sites to educate participants about the
consequences of borrowing from their 401(k) accounts. However, few
plans that we contacted had tools on their Web sites for participants
to project the potential impact of cashouts, hardship withdrawals, and
loans on their future retirement savings.
Some plan officials told us that plans had begun providing just-in-time
information on 401(k) leakage to participants entering certain life
phases to better meet the participants' needs. Regarding cashouts, for
example, one plan provided each separating participant with a worksheet
that contained a personalized projection of their current 401(k)
account balance, comparing dollar-for-dollar the advantages of keeping
the account tax-deferred by rolling it over into a qualified plan or
IRA with the consequences of cashing the balance out and paying the
associated penalties and taxes. Officials at another plan told us that
when an employer notified them that a large number of employees were
facing an imminent layoff, they would create a campaign to educate
participants about the steps they needed to take to preserve their
account balances after the layoff. Regarding hardship withdrawals, some
plans told us that they contacted participants after the 6-month
suspension period to inform them that they could reenroll in the 401(k)
plan. Another plan automatically reenrolled participants in their
401(k) plan after the 6-month suspension period. Officials at one plan
told us that they sought to intercept participants requesting a
disbursement from their retirement account, discussing with the
participant on the telephone the consequences of withdrawing the money.
Regarding loans, some plans request that the plan administrator set up
on-site seminars to cover various topics, such as the consequences of
job termination on a participant's outstanding loan.
Most Plans Informed Participants about the Short-term Costs of Leakage,
but Few Informed Participants about the Long-term Implications:
Almost all of the plans contacted told us that they sent a termination
package to participants at job separation that outlined the available
options for their account balance, but that these documents did not
contain information on the long-term implications of choosing to take a
cashout. These options included leaving the balance in the plan,
rolling the balance over into another employer-sponsored plan or IRA,
or cashing out their account balance. For example, one plan's standard
termination package included a document with information on the options
available to participants at termination, and on whom to call for more
information, and included a one-page summary illustrating the short-
term effects of cashing out of the plan. Few plans that we contacted
told us that they had tools on their Web sites, such as calculators,
for participants to project the potential effect on their future
retirement savings of taking a cashout.
Plan officials told us that they included information on the short-term
costs of hardship withdrawals, as required, whenever a participant
requested the hardship withdrawal. Hardship withdrawals come with a
number of short-term costs, including the 10 percent early withdrawal
penalty, the 6-month contribution suspension period, the inability to
return the withdrawn sum back to the plan, and the participant's
potential personal tax liability resulting from the withdrawal.
[Footnote 14] Many of the plans that we contacted required participants
to send a hard-copy of the hardship withdrawal application to the plan,
and some plans required participants to contact their plan
administrator or sponsor to request a hardship withdrawal. While
participants received information on the short-term costs associated
with a hardship withdrawal, the plans that we contacted provided little
information on the long-term implications of a hardship withdrawal on
retirement savings. Some plan officials told us that they did not
provide participants with any information on the long-term effects on
retirement of taking a hardship withdrawal.
Plan officials told us that plans informed participants about the short-
term costs of loans--including the loan amount, repayment schedule, and
tax consequences--through the plans' call centers, Web sites, or
publications. Some plan officials told us that even though they
informed participants of the short-term costs associated with taking a
loan, information about the long-term implications was largely omitted
because as long as the loan is repaid, it has a small overall impact on
account balances. Some plan officials that we contacted said that the
loan check sent to the participant also included a loan repayment
schedule, information on the tax consequences of taking the loan, and
the effects of defaulting on the loan. Plans that we contacted also
told us that plan Web sites offered participants loan calculators to
help the participant determine how much the loan repayment would cost
per pay period, and also offered articles designed to educate
participants about the consequences of borrowing from their account.
Some plans that we contacted offered loan modeling tools that allowed
participants to estimate the short-term impact of the loan on their
retirement balance. For example, one plan provided participants with an
online calculator tool that allows participants to determine what
effect a loan and its associated tax implications might have on their
future retirement benefit. However, few plans that we contacted
provided participants with information on the long-term consequences of
taking loans from their accounts.
Experts Said That Some Statutory Provisions Have Helped Reduce Leakage:
Three Statutory Provisions Are Said to Have Helped Reduce Leakage:
Early Withdrawal Penalty Provision:
The experts that we contacted said that the 10 percent penalty on early
withdrawals had likely reduced the incidence and amount of leakage
among 401(k) participants, but that its function as a disincentive
could be strengthened. One expert told us that he believed that the
penalty had significantly reduced the number of cashouts being taken
from 401(k) plans. Other experts noted that the penalty served as a
deterrent because participants were generally reluctant to pay
penalties, regardless of the amount. A plan administrator told us that
many participants contacting the call center to inquire about a
hardship withdrawal had reacted negatively to the information that they
would be required to pay a 10 percent penalty. Some experts questioned
whether the 10 percent penalty's power as a disincentive needed to be
strengthened to further discourage participants from removing money
from their accounts. Some felt that the percentage was too low to have
any major impact as a deterrent and suggested that the penalty needed
to be increased to further discourage participants from taking early
withdrawals. For example, one expert noted that young workers who
receive a distribution after leaving their first job may regard the
distribution as free money, and the penalty would only reduce the
amount of free money they received. Another expert said that the
penalty served more as a speed bump than as a deterrent for
participants earning higher incomes. Other experts noted that the
provision did not deter participants who were facing true hardships and
needed money from their accounts, regardless of the penalty assessed.
Because the incidence and amount of leakage from 401(k) accounts have
remained relatively steady, the 10 percent penalty has continued to
provide a steady source of revenue to IRS. Officials told us that the
penalty serves a dual purpose: it deters participants from tapping into
their 401(k) account when they have other sources of money available,
and it allows the federal government to recoup a portion of the subsidy
provided to keep the money tax-deferred. According to published IRS
data on early withdrawals from qualified retirement plans, including
401(k) plans and IRAs, more than 5 million tax filers paid $4.6 billion
in early withdrawal penalties in tax year 2006. As shown in figure 8,
the amount of early withdrawal penalties paid has increased since 1996,
while the average penalty paid per tax return has stayed about the
same.
Figure 8: Penalty Taxes Paid on Early Withdrawals from Qualified
Retirement Plans and Average Penalty Paid, 1996 through 2006:
[Refer to PDF for image: combined vertical bar and line graph]
Year: 1996;
Early withdrawal penalties paid: $2.85 billion;
Average penalty paid per tax return: $832.
Year: 1997;
Early withdrawal penalties paid: $2.99 billion;
Average penalty paid per tax return: $878.
Year: 1998;
Early withdrawal penalties paid: $3.42 billion;
Average penalty paid per tax return: $905.
Year: 1999;
Early withdrawal penalties paid: $3.84 billion;
Average penalty paid per tax return: $944.
Year: 2000;
Early withdrawal penalties paid: $4.18 billion;
Average penalty paid per tax return: $965.
Year: 2001;
Early withdrawal penalties paid: $3.89 billion;
Average penalty paid per tax return: $853.
Year: 2002;
Early withdrawal penalties paid: $4.11 billion;
Average penalty paid per tax return: $840.
Year: 2003;
Early withdrawal penalties paid: $3.92 billion;
Average penalty paid per tax return: $804.
Year: 2004;
Early withdrawal penalties paid: $4.07 billion;
Average penalty paid per tax return: $827.
Year: 2005;
Early withdrawal penalties paid: $4.13 billion;
Average penalty paid per tax return: $858.
Year: 2006;
Early withdrawal penalties paid: $4.56 billion;
Average penalty paid per tax return: $886.
Source: GAO analysis of IRS data.
Note: These IRS data include 401(k) participants as well as
participants in other qualified retirement plans, including IRAs. As a
result, we were unable to isolate the total amount of penalties paid by
401(k) participants. All dollar amounts are reported in constant 2008
dollars.
[End of figure]
Automatic Cashout Provision:
Experts said that the provision that lowered the threshold for plan
sponsors to cash out the accounts of separating participants
automatically has likely reduced the overall incidence of leakage.
Prior to this provision, employers could compel mandatory cashouts for
separating participants with account balances under $5,000. The change
reduced the threshold for an automatic cashout to account balances
valued at less than $1,000. For account balances valued at between
$1,000 and $5,000, employers were required to preserve the tax-deferred
status of the accounts, either by keeping the assets in the plan or
rolling the balances over into an IRA. Several experts noted that the
provision had dramatically reduced the incidence of leakage for
participants with balances of between $1,000 and $5,000, but the
overall effect was marginal because this group represents a small
proportion of the participant population.
We developed an illustration to show the maximum savings that could be
preserved over the course of a participant's working career under the
automatic cashout provision. Our illustration showed that the reduction
in the maximum cashout amount could result in greater savings over
time. (See table 8.)
Table 8: Illustration of the Effect of the Reduction in the Cashout
Amount on the Account Balance of a Medium-Income 401(k) Participant at
Age 65:
Age when cashout occurs: 25;
Decrease in account balance, with maximum $5,000 cashout: $41,405;
Decrease in account balance, with maximum $1,000 cashout: $8,281;
Maximum amount preserved under the cashout provision: $33,124.
Age when cashout occurs: 30;
Decrease in account balance, with maximum $5,000 cashout: $30,479;
Decrease in account balance, with maximum $1,000 cashout: $6,096;
Maximum amount preserved under the cashout provision: $24,383.
Age when cashout occurs: 35;
Decrease in account balance, with maximum $5,000 cashout: $23,952;
Decrease in account balance, with maximum $1,000 cashout: $4,790;
Maximum amount preserved under the cashout provision: $19,162.
Age when cashout occurs: 40;
Decrease in account balance, with maximum $5,000 cashout: $19,614;
Decrease in account balance, with maximum $1,000 cashout: $3,923;
Maximum amount preserved under the cashout provision: $15,691.
Age when cashout occurs: 45;
Decrease in account balance, with maximum $5,000 cashout: $15,123;
Decrease in account balance, with maximum $1,000 cashout: $3,025;
Maximum amount preserved under the cashout provision: $12,099.
Age when cashout occurs: 50;
Decrease in account balance, with maximum $5,000 cashout: $11,484;
Decrease in account balance, with maximum $1,000 cashout: $2,297;
Maximum amount preserved under the cashout provision: $9,187.
Age when cashout occurs: 55;
Decrease in account balance, with maximum $5,000 cashout: $8,704;
Decrease in account balance, with maximum $1,000 cashout: $1,741;
Maximum amount preserved under the cashout provision: $6,963.
Source: GAO.
Note: These illustrations are based on an individual who is born at the
beginning of 1970, begins participating in a 401(k) plan at age 21 in
1991, and retires at age 65 in 2035. We adopt the intermediate interest
and rate-of-return assumptions as reported in past and projected in
Social Security's most recent 2009 OASDI Trustees' Report. Involuntary
cashouts, as evaluated, are not rolled over to a qualified retirement
account, are taken out at the beginning of the year that the individual
reaches the age indicated, and incur the 10 percent tax penalty for
early withdrawal.
[End of table]
Loan Exhaustion Provision:
Experts said that the provision requiring participants in 401(k) plans
to exhaust their plan's loan provisions before taking a hardship
withdrawal had likely reduced leakage by promoting the use of loans
that are generally repaid and returned to the plan. Experts said that
the provision, which reduces hardship withdrawals, was a good rule and
made financial sense. One expert said that because loans remain in the
plan as an investment and retain assets when repaid, they resulted in
minimal leakage. In contrast, hardship withdrawals result in the
permanent removal of assets from the plan and cannot be returned to a
tax-deferred account. Thus, taking a loan prior to a hardship
withdrawal would preserve more assets for retirement. One expert told
us that it was important for participants to exhaust their loans to
reaffirm that the hardship exists and is long-term in nature, and the
expert emphasized that it was the responsibility of the plan
administrator to demonstrate that the hardship withdrawal was the
participant's loan of last resort. Another expert noted that while the
rule made financial sense, plan sponsors needed to more actively
encourage this practice, and not simply allow participants to take a
hardship withdrawal each time they faced a situation that fell within
the IRS definition of a hardship.
In January 2009, as a result of its compliance monitoring examinations,
IRS reported the failure of plans to meet hardship distribution
requirements as one of the top 10 issues facing 401(k) plans. Among
other things, IRS found that administrators of plans that offer
participant loans and hardship withdrawals are allowing participants to
take hardship withdrawals without first exhausting the plan's loan
provisions, as is currently required.[Footnote 15] Plan administrators
that we contacted said that most of their plans strictly adhered to
this provision; however, others stated that some plans were not
enforcing the provision. Several plan administrators told us that some
plans took participants at their word that they were facing a hardship
or believed that it was the plan sponsor's decision whether to fulfill
this requirement. For example, officials at one plan told us that they
asked participants whether they had taken a loan before granting a
hardship withdrawal, but that they did not verify the participants'
responses. Other plan administrators told us that they believed that
the requirement applied to some but not all 401(k) plans. Under current
rules, the loan exhaustion provision applies to all plans that offer
loans and hardship withdrawals, but there is no requirement for plans
to document compliance with this provision.
Our illustration shows the amount of retirement savings that could be
preserved by adhering to this provision. Specifically, we calculated
the effect on the growth in retirement savings for a medium-income
participant who obtained a combination of a $2,500 loan and a $2,500
hardship withdrawal, rather than taking a $5,000 hardship withdrawal.
As shown in figure 9, participants obtaining even a portion of the
needed amount in the form of a loan could result in additional
retirement savings over the course of a working career.
Figure 9: Illustration of the Effect of Removing $5,000 from a 401(k)
Account by Taking a Loan before a Hardship Withdrawal, on the Account
Balance of a Medium-Income Participant at Age 65:
[Refer to PDF for image: vertical bar graph]
Age: 35;
No leakage: $588,000;
Hardship/loan: $566,000;
Hardship only: $553,000.
Age: 45;
No leakage: $588,000;
Hardship/loan: $571,000;
Hardship only: $563,000.
Age:
No leakage: $588,000;
Hardship/loan: $577,000;
Hardship only: $572,000.
Source: GAO.
Note: These illustrations are based on an individual who is born at the
beginning of 1970, begins participating in a 401(k) plan at age 21 in
1991, and retires at age 65 in 2035. We adopt the intermediate interest
and rate-of-return assumptions as reported in past and projected in
Social Security's most recent 2009 OASDI Trustees' Report and use their
medium level for annual earnings. Employee contributions are 6 percent
and receive a 3 percent employer matching contribution. Loans incur a
$100 fee deducted from the account balance, are taken out at the
beginning of the year that the individual reaches the age indicated,
and are repaid in 5 years at a fixed interest rate equal to the rate of
return at the time the loan is made. Hardship withdrawals incur a 10
percent tax penalty for early withdrawal, are taken out at the
beginning of the year the individual reaches the age indicated, and
participant contributions and employer matching contributions are
suspended for a period of 6 months. The simple hardship withdrawal case
assumes a $5,000 withdrawal, while the hardship withdrawal and loan
combination divides the $5,000 into a $2,500 loan and a $2,500 hardship
withdrawal. While the individual's contributions are suspended for 6
months subsequent to receiving a hardship withdrawal, loan repayments
continue for the entire 5-year repayment period, including the 6 months
during which regular and matching contributions are suspended.
[End of figure]
Experts Said That the Provision Requiring Suspension of Contributions
May Exacerbate the Long-term Effects of Leakage:
Experts noted that the statutory provision requiring a 6-month
suspension of participant contributions following a hardship withdrawal
may increase the amount of leakage by prohibiting those participants
who can contribute to their 401(k) accounts from doing so. Treasury
officials told us that the suspension period was intended to serve as a
test to ensure that the hardship was real, and that the participant did
not have other assets available to address the hardship. Many of the
experts noted that the provision did little to deter participants from
taking hardship withdrawals. For example, one expert told us that while
the provision may have had some effect as a deterrent to taking a
hardship in theory; in practice, it only affected people already
experiencing a hardship.
Other experts noted that the provision seemed to contradict the goal of
creating retirement income. One expert said that the provision
unnecessarily kept able participants from making contributions, such as
an employee who needed an infusion of cash for a discrete, one-time
event, such as a home purchase. Other experts characterized the
suspension period as excessive and more of an inconvenience than an
effective deterrent. For example, one expert noted, participants who
need money and initiate hardship withdrawals must pay taxes and
penalties and are prevented from making contributions, leaving them
with 50 percent or less of the money they had withdrawn. Several
experts suggested remedies, such as shortening or repealing the
suspension period, or allowing participants to at least keep their
employer match during the suspension period to begin making up lost
ground.
Our illustration shows the effect of the 6-month suspension on the
accumulation of retirement income. As shown in table 9, the suspension
period would have the greatest impact on the retirement savings of
midcareer participants earning a medium income.
Table 9: Illustration of the Effect of Suspending Participant
Contributions Following a $5,000 Hardship Withdrawal on a Medium-Income
Participant's Account Balance at Age 65:
Age at which hardship withdrawal is taken: 25;
401(k) account balance at age 65: With no suspension: $540,023;
401(k) account balance at age 65: With 6-month suspension: $533,886;
Potential losses attributable to suspension of contributions: $6,137.
Age at which hardship withdrawal is taken: 35;
401(k) account balance at age 65: With no suspension: $560,661;
401(k) account balance at age 65: With 6-month suspension: $552,574;
Potential losses attributable to suspension of contributions: $8,088.
Age at which hardship withdrawal is taken: 45;
401(k) account balance at age 65: With no suspension: $570,933;
401(k) account balance at age 65: With 6-month suspension: $562,860;
Potential losses attributable to suspension of contributions: $8,073.
Age at which hardship withdrawal is taken: 55;
401(k) account balance at age 65: With no suspension: $578,337;
401(k) account balance at age 65: With 6-month suspension: $572,064;
Potential losses attributable to suspension of contributions: $6,272.
Source: GAO.
Note: These illustrations are based on an individual who is born at the
beginning of 1970, begins participating in a 401(k) plan at age 21 in
1991, and retires at age 65 in 2035. We adopt the intermediate interest
and rate-of-return assumptions as reported in past and projected in
Social Security's most recent 2009 OASDI Trustees' Report. Employee
contributions are 6 percent and receive a 3 percent employer matching
contribution. The $5,000 hardship withdrawals incur a 10 percent tax
penalty for early withdrawal and are taken out at the beginning of the
year that the individual reaches the age indicated. We contrast the age
65 401(k) account balance when participant contributions and employer
matching contributions are suspended for a period of 6 months and when
contributions continue without suspension. In this table, we calculated
the forgone savings associated with the suspension of a 6 percent
employee contribution and a 3 percent employer matching contribution
for a period of 6 months. Totals do not add due to rounding.
[End of table]
Finally, several experts noted that the 401(k) hardship withdrawal
definition was too broad and gave participants access to money for
circumstances that were both voluntary and foreseeable. For example,
under current rules, participants may take a hardship withdrawal for
purchasing their primary residence, which some experts said did not
constitute an immediate and heavy financial need. Moreover, the 401(k)
definition of hardship differs from hardship equivalents under other
qualified plans, such as 457(b) retirement plans.[Footnote 16] Under a
457(b) plan, for example, a participant may take a hardship
distribution only when faced with an unforeseeable emergency, which the
regulations define as a severe financial hardship resulting from an
illness or accident, loss of property due to casualty, or other similar
extraordinary and unforeseeable circumstances arising as a result of
events beyond the control of the participant or beneficiary. In
addition, the regulations also state that the purchase of a home and
the payment of college tuition are generally not unforeseeable
emergencies.
Conclusions:
There are many reasons why participants may choose to use their
retirement savings prior to retirement, and some of these choices may
involve a rational trade-off between immediate financial emergencies
and future retirement needs. U.S. workers continue to feel the effects
of the current economic downturn in the form of job losses, home
foreclosures, and the depreciation of 401(k) retirement savings. With
home values down and lending sometimes difficult to obtain, some
workers may see their accrued 401(k) savings as their last protection
against financial hardship. Yet, even small amounts of leakage can have
a significant impact on the retirement savings of some plan
participants.
While tapping into a 401(k) account to meet short-term needs may be
rational under certain circumstances, some leakage could be mitigated
if participants had adequate information on the long-term implications
of their actions. Cashouts can be the most damaging form of 401(k)
leakage, are the least regulated, and appear to run counter to the goal
of retirement savings. However, many participants continue to take this
option when separating from their employer, in part because the option
is often presented to them with little or no information on its long-
term consequences. With better information on the consequences of the
various forms of leakage, participants may choose to preserve their
retirement savings, resulting in a better retirement outcome.
Participants facing sudden and unanticipated hardships would also
benefit from the assurance that they are using the most appropriate and
least damaging option, thereby minimizing the negative impacts on their
overall retirement preparedness. For example, to avoid unnecessary
leakage, employers should not approve participants for hardship
withdrawals until they are certain that participants have exhausted the
plans' loan provisions. In addition, under current hardship rules,
participants who could continue making retirement contributions after
taking a hardship withdrawal are barred from doing so. This suspension
of contributions also prevents participants from receiving employer
matching contributions and will likely leave them with a lower account
balance at retirement. Ensuring that participants choose the path that
causes the least harm to their retirement accounts and continue to make
retirement contributions whenever possible may help mitigate the
adverse impacts of leakage that otherwise will linger into retirement.
Matter for Congressional Consideration:
To help participants recover more quickly from a hardship situation,
Congress should consider changing the requirement for the 6-month
contribution suspension following a hardship withdrawal.
Recommendations for Executive Action:
To support the goal of providing plan participants with understandable
and useful information about their employer-provided retirement plan
benefits, we recommend that the Secretary of Labor promote industry
best practices by encouraging plans to take the following actions:
* Include on their participant Web sites information on their plan
loan, hardship withdrawal, and cashout provisions, including examples
of the long-term consequences of each provision. For example, plans
could place a copy of the summary plan description in an electronic
form that participants could reference as needed, or provide modeling
tools.
* Provide separating participants with a projection of their account
balance under different scenarios, such as when assets are left in a
tax-deferred retirement account compared with those assets cashed out
in the form of a lump-sum distribution.
To prevent unnecessary leakage and increase compliance with existing
regulatory requirements, we recommend that the Secretary of the
Treasury clarify that the loan exhaustion provision applies to all
plans that permit both participant loans and hardship withdrawals, and
require plans to document that participants have exhausted available
plan loans before allowing a hardship withdrawal.
Agency Comments:
We provided a draft of this report to the Secretary of Labor and the
Secretary of the Treasury for review and comment. In comments on a
draft of this report (which are reprinted in appendix III), the
Department of Labor agreed to consider our recommendations as it
developed regulations and other guidance to assist plan participants
and beneficiaries in understanding their benefits and distribution
options. Labor also provided technical comments on a draft of this
report, which we incorporated as appropriate. In its comments
(reprinted in appendix IV), the Department of the Treasury agreed to
publish an article highlighting the requirements of the hardship
withdrawal provisions, giving special attention to the scope of the
loan exhaustion requirement and the need for plans to document
compliance.
As agreed with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days
from its issue date. At that time, we will send copies of this report
to relevant congressional committees, the Secretary of Labor, the
Secretary of the Treasury, and other interested parties. In addition,
the report will be made available at no charge on the GAO Web site at
[hyperlink, http://www.gao.gov].
If you or your staff have any questions about this report, please
contact me at (202) 512-7215 or bovbjergb@gao.gov. Contact points for
our Offices of Congressional Relations and Public Affairs may be found
on the last page of this report. GAO staff who made contributions to
this report are listed in appendix V.
Sincerely yours,
Signed by:
Barbara D. Bovbjerg:
Director, Education, Workforce, and Income Security Issues:
[End of section]
Appendix I: Scope and Methodology:
The objectives of this study were to identify (1) the incidence,
amount, and relative significance of the different forms of 401(k)
leakage; (2) how 401(k) plans inform participants about hardship
withdrawal provisions, loan provisions, and options at job separation,
including the short-term and long-term costs associated with each; and
(3) what is known about how various policies may affect the incidence
of 401(k) leakage. We conducted this performance audit from August 2008
to August 2009 in accordance with generally accepted government
auditing standards. Those standards require that we plan and perform
the audit to obtain sufficient, appropriate evidence to provide a
reasonable basis for our findings and conclusions based on our audit
objectives. We believe that the evidence obtained provides a reasonable
basis for our findings and conclusions based on our audit objectives.
We determined that the data that we analyzed were sufficiently reliable
for the purposes of this report.
Incidence and Amount of 401(k) Leakage:
To determine the principal forms of 401(k) leakage, we interviewed
industry and academic experts, reviewed laws and regulations, and
analyzed existing studies on leakage. We then identified cashouts at
job change, hardship withdrawals, and participant loans as the three
principal forms of leakage.
To determine the incidence and amount of these principal forms of
leakage over time, we analyzed data from the 1996, 2001, and 2004
panels of the U.S. Census Bureau's Survey of Income and Program
Participation (SIPP), using the data from survey respondents on their
participation in 401(k) plans contained in the Pension and Retirement
Topical Module (collected in 1998, 2003, and 2006). We excluded SIPP
participants who were younger than age 15 or older than age 60 at the
time of the interview, and used this subset of the SIPP data to develop
estimates of the number of 401(k) plan participants who reported taking
a cashout, hardship withdrawal, or loan from their account prior to
retirement. Because SIPP is based upon a probability sample, we
followed the Census Bureau technical documentation in deriving all
percentage and dollar-value estimates and the 95 percent confidence
intervals that correspond to these estimates.
To determine the aggregate loan default amounts over time, we analyzed
published annual statistics from 1996 through 2006 the Department of
Labor's Private Pension Plan Bulletins Abstract of Form 5500 Annual
Reports and tabulated the amount of loan defaults that plan sponsors
reported releasing to participants.[Footnote 17] To determine the
amount of early withdrawal penalties on qualified retirement accounts
that plan participants paid, we analyzed published annual Internal
Revenue Service (IRS) statistics from 1996 through 2006 on estimated
individual income tax liabilities, credits, and payments. Because IRS
reports the penalty amounts in aggregate for all qualified plans,
including individual retirement accounts (IRA) and 401(k) plans, we
were unable to isolate the penalties paid only by 401(k) participants.
To determine the recent prevalence of leakage, we analyzed summary data
on the incidence and amount of hardship withdrawals and loans from 2005
through 2008 that we obtained from major 401(k) plan administrators,
which represented about 22 million 401(k) participants and over $1
trillion in 401(k) plan assets. We were not able to acquire similar
year-to-year data on cashouts from 401(k) plans. While the data that we
received were not nationally representative, they provided a snapshot
of the incidence and amount of the two forms of leakage in recent years
at several of the largest 401(k) plan administrators.
Relative Significance of Leakage Forms:
To illustrate the relative significance of leakage over time, we
developed a model to tabulate 401(k) account balances for various
hypothetical individuals at age 65 that differed depending on when and
whether these individuals tapped into their 401(k) account prior to
retirement. We ran a range of scenarios to simulate the effect that
various forms and amounts of leakage would have on a participant's
retirement savings. In developing these scenarios, we considered such
factors as the participant's age, earnings, wages, contribution rates,
years until retirement, as well as historical and projected interest
rates and earnings levels, loan administration fees, and penalties
associated with leakage. We based our illustrations on an individual
who was born at the beginning of 1970, began participating in a 401(k)
plan at age 21 in 1991, and will retire at age 65 in 2035. We used
historical values and future projections for interest rate and rate-of-
return assumptions as reported in past and projected under the
intermediate cost assumptions in Social Security's The 2009 Annual
Reports of the Board of Trustees of the Federal Old-Age and Survivors
Insurance and Federal Disability Insurance Trust Funds (also known as
the 2009 OASDI Trustees' Report). Also, we used scaled earnings for
low, medium, and high annual earners as reported in past and projected
in the 2009 OASDI Trustees' Report. We assumed that employee
contributions to the 401(k) are 6 percent of the individual's wages and
received a 3 percent employer matching contribution. Loans taken from
the 401(k) incur a $100 fee that is deducted from the account balance,
were taken out at the beginning of the year that the individual reached
the age indicated in our analyses, and were repaid over a 5-year period
at a fixed interest rate equal to the rate of return at the time that
the loan was made. Hardship withdrawals from the 401(k) incur a 10
percent tax penalty for early withdrawal and are taken out at the
beginning of the year that the individual reaches the age indicated in
our analyses, and participant contributions and employer matching
contributions are suspended for the subsequent 6-month period. Partial
and full cashouts also incur a 10 percent tax penalty for early
withdrawal and are taken out at the beginning of the year that the
individual reaches the age indicated in our analysis. We generally
assume (except where otherwise specified in the report) that the
individual does not resume his or her own and employer matching
contributions to a 401(k) account for 12 months. Finally, we calculated
the amount of forgone retirement savings at age 65 for an individual
who took a loan, hardship withdrawal, or partial cashout in the amount
of $5,000.
Participant Information:
To determine how plans inform participants about leakage, we
interviewed 26 plan administrators representing at least 80 percent of
401(k) participants and 65 percent of 401(k) assets. We selected our
sample of administrators using industry rankings of the leading firms
that were based on the number of plans and participants, the value of
the plan assets, and the quality of their participant services. To
ensure a range of views, we contacted 401(k) plan recordkeepers, plan
sponsors, and third-party administrators representing large and small
401(k) plans. As part of these efforts, we conducted 10 site visits
during which we interviewed representatives and toured a participant
call center. The documents that we reviewed included plans' mandatory
tax notices, summary plan descriptions, plan brochures, loan and
hardship withdrawal forms, and prototype plan documents. We also
reviewed selected 401(k) plan sponsor and administrator Web sites,
current law, and regulations. To learn about industry standards and
practices, we interviewed 401(k) plan administrators; plan sponsors;
industry and academic experts; and Labor, Department of the Treasury,
and IRS officials and reviewed relevant literature.
Policy Provisions Affecting 401(k) Leakage:
To identify what is known about how various policy options may affect
the incidence of leakage, we reviewed provisions in current law,
regulations, and legislative proposals and identified nine policy
options likely to affect leakage. Next, we interviewed selected
industry and academic experts to gather their opinions on which of
these policy provisions would likely affect leakage. We selected
experts who were cited in the literature on retirement leakage, were
referred to us during interviews, and are known in the pension and
retirement field. To ensure that we had a range of views, we included
experts from academic, practitioner, participant advocacy, and industry
backgrounds. We analyzed the experts' responses and identified the
provisions that they indicated were likely to affect leakage. We then
used our illustration model to simulate the effect that each of the
identified provisions may have on a hypothetical 401(k) participant's
retirement savings at age 65. These illustrations are based on an
individual who is born at the beginning of 1970, begins to participate
in a 401(k) plan at age 21 in 1991, and retires at age 65 in 2035. We
use historical values and future projections for interest rate and rate-
of-return assumptions as reported in past and projected in Social
Security's most recent 2009 OASDI Trustees' Report under the
intermediate cost assumptions. We used scaled earnings for low, medium,
and high annual earners as reported in past and projected in the 2009
OASDI Trustees' Report. In each scenario, we assumed that employee
contributions of 6 percent of the participant's earnings to the 401(k)
and received a 3 percent employer matching contribution. We used the
following assumptions to distinguish each form of leakage:
* Loans taken from the 401(k) incurred a $100 fee that is deducted from
the account balance. We assumed that loans were taken out at the
beginning of the year that the individual reached the age indicated in
our analyses, and that loans were repaid over a 5-year period at a
fixed interest rate equal to the rate of return at the time that the
loan is made.
* Hardship withdrawals from the 401(k) incurred a 10 percent tax
penalty for early withdrawal and were taken out at the beginning of the
year that the individual reached the age indicated in our analyses.
Participant contributions and employer matching contributions were
suspended for the subsequent 6-month period.
* Partial and full cashouts incurred a 10 percent tax penalty for early
withdrawal and were taken out at the beginning of the year that the
individual reached the age indicated by in our analyses. We generally
assumed (except where otherwise specified in the report) that the
individuals taking a cashout did not resume their elective or employer
matching contributions to their 401(k) accounts for 12 months.
Next, we ran five separate scenarios to simulate the effect of selected
provisions on our hypothetical individual's retirement savings at age
65. Specifically, we simulated the effect of each of the following
scenarios:
* effect of a total cashout of an entire 401(k) account at various
ages;
* effect of a loan default on a $5,000 loan after 1-year repayment;
* effect of reducing the involuntary automatic cashout from $5,000 to
$1,000;
* effect of exhausting a plan's loan provision before taking a hardship
withdrawal; and:
* effect of a 6-month contribution suspension following a hardship
withdrawal.
[End of section]
Appendix II: 401(k) Administrators That GAO Contacted:
ADP Retirement Services:
Aon:
Barclays:
Capital Research:
Centier Bank:
Charles Schwab:
Diversified Investment Advisors:
Fidelity:
Hewitt Associates:
ING:
JP Morgan Chase:
John Hancock Financial Services:
Marshall & Ilsley Trust Company:
Merrill Lynch:
Mercer:
MetLife:
Mass Mutual:
Nationwide:
New York Life:
Prudential:
State Street:
T. Rowe Price:
Vanguard:
Wachovia:
Watson Wyatt:
Wells Fargo & Company:
[End of section]
Appendix III: Comments from the Department of Labor:
U.S. Department of Labor:
Employee Benefits Security Administration:
Washington, D.C. 20210:
July 10, 2009:
Ms. Barbara D. Bovbjerg:
Director, Education, Workforce, and Income Security Issues:
United States Government Accountability Office:
Washington, DC 20548:
Dear Ms. Bovbjerg:
We have reviewed the Government Accountability Office's (GAO) draft
report entitled "401(k) Plans: Policy Changes Could Reduce the Long-
Term Effect of Leakage on Workers' Retirement Savings," (GAO-09-715)
and the recommendation contained therein as it relates the Secretary of
Labor.
Specifically, the GAO is recommending that the Secretary promote
industry best practices by encouraging plans to 1) include on the
participant Web site information on their plan's loan, hardship
withdrawal, and cashout provisions, including examples of long-term
consequences of each. For example, plans could place a copy of the
summary plan description in an electronic form that participants could
reference as needed, or provide modeling tools; and 2) provide
separating participants with a projection of their account balance
under different scenarios, such as when assets are left in a tax-
deferred retirement account compared to those cashed out in the form of
a lump-sum distribution.
The Department shares the GAO's interest in helping participants and
beneficiaries to understand the importance of retirement savings and
the implications of their benefit distribution options. In this regard,
the Department's participant and plan sponsor outreach and education
programs as well as its numerous publications all seek to advance this
goal. As we move forward in the development of regulations and other
guidance designed to assist plan participants and beneficiaries in
understanding their benefits and distribution options, we will give
serious consideration to the recommendation contained in your report.
EBSA is committed to protecting the employer-sponsored benefits of
American workers, retirees, and their families. We appreciate having
had the opportunity to review and comment on the draft report. Please
do not hesitate to contact us if you have questions concerning this
response or if we can be of further assistance.
Sincerely,
Signed by:
Michael L. Davis:
Deputy Assistant Secretary:
[End of section]
Appendix IV: Comments from the Department of the Treasury:
Department Of The Treasury:
Washington, D.C. 20220:
August 7, 2009:
Ms. Barbara D. Bovbjerg:
Director, Education, Workforce, and Income Security Issues:
United States Government Accountability Office:
Washington, DC 20548:
Dear Ms. Bovbjerg:
We appreciate the opportunity to comment on the Government
Accountability Office's draft report titled 401(k) Plans: Policy
Changes Could Reduce the Long-Term Effects of Leakage on Workers'
Retirement Savings ((GAO-09-715). The report includes recommendations
of steps that could be taken to reduce the incidence of retirement
savings leakage.
The report describes the provision of the section 401(k) regulations
that requires a participant to exhaust the availability of a loan under
a plan before the participant is permitted to take a hardship
withdrawal and notes that several experts have endorsed this provision.
The IRS has recently reported that failure to comply with the section
401(k) hardship withdrawal requirements is among the top ten section
401(k) plan compliance issues. To reduce retirement savings leakage due
to hardship withdrawals, the report recommends that Treasury take steps
to clarify that the plan loan exhaustion requirement applies to all
plans that permit both participant loans and hardship withdrawals and
to require plans to document compliance with the requirement.
Treasury and the IRS are committed to ensuring that retirement plans
accomplish their stated goal of providing retirement income. In
particular, to improve compliance with the section 401(k) regulatory
provision that requires the exhaustion of plan loans before any
hardship withdrawal may be taken, the IRS will publish an article in an
upcoming edition of the Employee Plans News (which is distributed to
more than 57,000 subscribers) highlighting the requirements of the
hardship withdrawal provisions. The article will give special attention
to the scope of the loan exhaustion requirement and the need to
document compliance.
If you have questions concerning this response, please contact me.
Sincerely,
Signed by:
J. Mark Iwry:
Senior Advisor to the Secretary:
Deputy Assistant Secretary for Retirement and Health Policy:
[End of section]
Appendix V: GAO Contact and Staff Acknowledgments:
GAO Contact:
Barbara D. Bovbjerg, (202) 512-7215 or bovbjergb@gao.gov:
Staff Acknowledgments:
In addition to the individual listed above, David Lehrer, Assistant
Director; Jonathan S. McMurray, Analyst-in-Charge; Nicole Harkin; and
Gene Kuehneman made key contributions to this report. Carl Barden,
Susannah Compton, Cathy Hurley, Ed Nannenhorn, Roger Thomas, and Walter
Vance also made important contributions.
[End of section]
Footnotes:
[1] Employers may sponsor defined benefit (DB) or defined contribution
(DC) plans for their employees. DB plans promise to provide a benefit
that is generally based on an employee's salary and years of service.
See 29 U.S.C. § 1002(35). DB plans use a formula to determine the
ultimate pension benefit participants are entitled to receive. Under a
DC plan, such as a 401(k) plan, employees have individual accounts to
which the employee, employer, or both make contributions, and benefits
are based on contributions, along with investment returns (gains and
losses) on the accounts. See 29 U.S.C. § 1002(34).
[2] See GAO, Private Pensions: Changes Needed to Provide 401(k) Plan
Participants and the Department of Labor Better Information on Fees,
[hyperlink, http://www.gao.gov/products/GAO-07-21] (Washington, D.C.:
Nov. 16, 2006). In the 2006 report, we found that participants paid for
the majority of investment fees and an increasing amount of plan
recordkeeping fees, and that under the Employee Retirement Income
Security Act of 1974, plans were not required to disclose information
on 401(k) fees being borne by individual participants. While the
current report focuses on participants' elective removal of their
accrued retirement savings, we recognize that 401(k) fees have a
considerable long-term effect on the accumulation of retirement income.
See GAO, Private Pensions: Participants Need Information on Risks They
Face in Managing Pension Assets at and During Retirement, [hyperlink,
http://www.gao.gov/products/GAO-03-810] (Washington, D.C.: July 29,
2003).
[3] Both cashouts and hardship withdrawals result in the permanent
removal of money from 401(k) accounts. However, participant loans are
borrowed from the plan and must be paid back to the plan. The borrowed
amount does not leave the plan, unless the participant fails to repay
according to the terms of the loan. A loan default would result in a
distribution that would permanently reduce the account balance in a
401(k). In addition, a participant taking a loan may achieve slightly
lower savings at retirement if the amount of loan interest paid back to
the account during the loan repayment period is less than the market
rate of return. Participants who have an outstanding loan balance at
job separation generally must repay the loan balance in full or the
loan will default, triggering an early distribution.
[4] The Internal Revenue Code, as amended, exempts certain early
distributions from the penalty if the distributions are made to a
beneficiary or estate on or after death; made on account of total and
permanent disability; made as part of a series of substantially equal
periodic payments over the life expectancy of the owner or life
expectancies of the owner and the beneficiary; equal to or less than
deductible medical expenses (7.5 percent of adjusted gross income);
made due to an IRS levy of the plan; made to individuals called to
active duty after September 11, 2001, and before December 31, 2007;
made to a participant after separated from service with an employer in
or after the year that he or she reaches age 55; made to an alternate
payee under a qualified domestic relations order; dividends from
employee stock ownership plans; or made to an individual whose main
home was located in a designated hurricane disaster area and who
sustained an economic loss by reason of the hurricane. Additionally,
some plan sponsors offer Roth 401(k) plans that allow plan participants
to make elective after-tax contributions through payroll deduction.
[5] For 2006 estimates, see Investment Company Institute, "The U.S.
Retirement Market, 2007," Research Fundamentals, vol. 17, no. 3 (2008).
[6] GAO, 401(k) Pension Plans: Loan Provisions Enhance Participation
But May Affect Income Security for Some, [hyperlink,
http://www.gao.gov/products/GAO/HEHS-98-5] (Washington, D.C.: Oct. 1,
1997).
[7] Different portions of taxable income are taxed at different rates.
IRS refers to the tax rate applied to the last dollar of income as the
"marginal tax rate" for that return.
[8] IRS makes guidance available to participants on the rules governing
distributions from qualified retirement accounts, including allowable
exceptions, on its Web site: [hyperlink, http://www.irs.gov].
[9] We analyzed data from the Pension and Retirement Topical Module
collected during wave 7 for the 1996, 2001, and 2004 SIPP panels.
[10] The Pension and Retirement Topical Module for the 2004 SIPP was
collected in the seventh wave of participant interviews during 2006.
[11] The three administrators that provided us with recent data
represent about 22 million 401(k) participants and over $1 trillion in
401(k) plan assets.
[12] In some cases, participants who separate from one employer with an
outstanding loan balance can transfer that balance over to their new
employer and continue making repayments. Other plans allow former
participants to make loan payments by check, although administrators
told us that the administrative costs of doing so were high.
[13] According to Treasury officials, a distribution from a 401(k)
accounts as a result of a loan default could compel some lower-income
earners to pay income taxes when they otherwise would not be compelled
to do so.
[14] These costs are short term because participants experience them
shortly after taking a hardship distribution. However, each of these
costs has long-term implications on a participant's retirement balance.
[15] IRS Reg. 26 C.F.R. § 1.401(k)-1(d)(3)(iv)(E), which applies to all
401(k) plans, states that a distribution is deemed necessary to satisfy
an immediate and heavy financial need of an employee if (1) the
employee has obtained all other currently available distributions and
loans under the plan and all other plans maintained by the employer and
(2) the employee is prohibited, under the terms of the plan or an
otherwise legally enforceable agreement, from making elective
contributions and employee contributions to the plan and all other
plans maintained by the employer for at least 6 months after receipt of
the hardship distribution.
[16] The 457(b) plans are deferred compensation plans available for
certain state and local governments and nongovernmental tax-exempt
entities.
[17] Labor collects information on 401(k) participant loan defaults
through the Form 5500. This form (1) includes information on the plan's
sponsor, the features of the plan, and the number of participants and
(2) provides more specific information, such as plan assets,
liabilities, insurance, and financial transactions. Filing this form
satisfies the requirement for the plan administrator to file annual
reports concerning, among other things, the financial condition and
operation of plans. Labor uses this form as a tool to monitor and
enforce plan sponsors' responsibilities under the Employee Retirement
Income Security Act.
[End of section]
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