Plan leakage: where retirement savings disappear

A defined contribution plan can have high participation, a generous match and a sound investment menu and still leave a large share of participants short at retirement. One reason that rarely appears on the committee agenda is leakage: money that leaves the plan before retirement and is not replaced.

The channels

Cash-outs at job change. When employees leave, many take the balance in cash rather than rolling it over, and pay income tax and the 10 percent additional tax to do it. For younger and lower-paid employees this is usually the largest single source of leakage. Balances under the plan's mandatory distribution threshold, which SECURE 2.0 raised to $7,000 beginning in 2024, can be forced out of the plan; balances between $1,000 and that threshold must be rolled to an IRA if the participant does not respond, but many of those IRAs are later cashed out as well.

Loans. A loan repaid on schedule is not leakage. The damage occurs when an employee leaves with a loan outstanding. The unpaid balance becomes a loan offset, and under current law the participant has until the tax filing deadline, including extensions, to replace that amount in an IRA or another plan. Most do not, and the offset becomes a taxable distribution.

Hardship and emergency withdrawals. These are permanent. SECURE 2.0 made them easier to take: participants may now self-certify hardship, a $1,000 emergency withdrawal is available once a year with a three-year repayment window, and plans may offer a pension-linked emergency savings account for non-highly compensated employees. Each of these helps someone in a crisis. Each also increases the amount leaving the plan.

Smaller channels include in-service withdrawals after 59½ that are spent rather than rolled, and the gap between termination and the date a new employer's plan accepts roll-ins, during which balances sit idle or are cashed out.

Measuring it

Leakage is rarely measured, which is why it is rarely managed. The recordkeeper already has what is needed: distributions by type and by age, loan defaults and offsets, terminated participants with balances, rollover versus cash election rates and force-outs. From that data we calculate a leakage rate by channel (dollars leaving before retirement as a share of beginning balances) and break it down by age, tenure and pay band.

The results usually show two things. First, leakage is concentrated: a small number of channels and employee groups account for most of the loss. Second, the effect on retirement income is larger than the dollar amount suggests, because the money leaves young and would have compounded for decades. We project both.

Design levers

• Loan policy. Limit outstanding loans to one at a time, and allow terminated employees to continue repaying by direct debit so that a job change does not force a default.
• Portability. Accept roll-ins from prior employers without friction, and consider auto-portability. SECURE 2.0 provided a prohibited transaction exemption for automatic portability services that move small balances from a prior employer's plan or default IRA into the new employer's plan without participant action.
• The mandatory distribution threshold. Decide deliberately whether forcing out small balances serves participants or simply moves the problem to an IRA that is cashed out later.
• Emergency savings. A pension-linked emergency savings account or an after-tax account gives employees a source of cash that is not their retirement balance.
• Communication at separation. The distribution election is the moment that matters most. A clear explanation of rollover options, delivered by the recordkeeper at termination rather than buried in a packet, changes outcomes.

Why it belongs on the committee agenda

Leakage determines whether the plan does what it exists to do. It is also measurable, which makes it unusual among plan outcomes: the committee can set a target, track it annually and see the effect of each design change. We produce the baseline, the breakdown and the projection, and present the design options with their cost and their expected effect on retirement income.

This article is general information about the topics discussed and is not actuarial, legal or tax advice for any specific plan or employer.