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Tuesday, July 26, 2005

Bad News for Opt-Out Accounts

This is not good news for add-on, opt-out accounts.  Younger workers, when forced to make a choice due to departure from a firm cash out their retirement saving plans in large numbers.  This implies that, when faced with checking a box on a tax return, something that requires active participation, many may opt-out and those that do may be the workers most likely to benefit from such accounts in the long-run.  Thus, the ability of these accounts to increase national saving and solve market failure problems in the retirement savings market is suspect if these statistics carry over to opt-out, add-on accounts:

Cashing out their future gains, By Andrea Coombes, MarketWatch: Almost half of workers who switched jobs last year cashed out their 401(k) rather than maintain it in a retirement plan, according to a new survey, a move financial planers (sic) say can be costly in the long run.  Forty-five percent of departing workers opted for a cash distribution, rather than leaving the money in the 401(k) or rolling it over to an IRA… The people most likely to cash out were younger, had a shorter tenure at the company or had a low 401(k) balance, the study found.  Among workers in their 20s, 66% cashed out their plans compared with about 31% of workers in their 50s. … The propensity to cash out is even fairly common among slightly older workers: 42% of those in their 40s took the cash. …  workers pay a steep price to pull the money out: An immediate 20% withholding (which will be adjusted up or down based on their marginal tax rate when they file their tax return), plus a 10% withdrawal penalty. … Higher balances cashed out less often. … Almost three-quarters of those with 401(k) balances less than $10,000 took the cash. That dropped to 8% among those with balances of $50,000 to $60,000. …  the study looked at plans last year that allowed workers with low account balances to leave their money in the company plan, and the findings suggest even a "save the money" default won't change some workers' urge to cash out...

One note on the statistics and their interpretation.  The statistics appear to imply that if you can get workers to avoid taking out small balances, then they will leave the money in the accounts once the amount crosses some threshold.  Be careful with that interpretation since those with large accounts are not a random sample.  To have a large account, you have to avoid the temptation to withdraw balances when they are small.  The experiment to run is to take workers who cashed out and increase the size of their accounts to see if behavior changes, but that experiment is not performed naturally by the market process.

    Posted by on Tuesday, July 26, 2005 at 02:25 PM in Economics, Saving, Social Security | Permalink  TrackBack (0)  Comments (11)


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