Early Withdrawal Does Not Negate 401(k) Importance

Cashouts typically reduce average 401(k) assets at age 65 by only about 5 percent.

The annual contribution flow to 401(k) savings programs now exceeds $100 billion. More than 35 million workers are participating in these plans offered by their employers. In Pre-retirement Cashouts and Foregone Retirement Saving: Implications for 401(k) Asset Accumulation (NBER Working Paper No. 7314), NBER Research Associates James Poterba, Steven Venti, and David Wise consider the effect on retirement income of pre-retirement withdrawal of 401(k) assets when workers change jobs. Such "cashouts" typically reduce average 401(k) assets at age 65 by only about 5 percent, they find. This is largely because most households who are eligible for a lump sum distribution when they change jobs choose to keep their accumulated 401(k) assets in the retirement saving system. They either leave their assets in their previous employer's 401(k) plan, or they roll the assets over to another retirement saving account, such as a new 401(k) plan, or an Individual Retirement Account.

Most of those who do withdraw assets have very small accumulated balances. So, for households headed by individuals now 39 years old and reaching retirement age in 2025, the authors predict that average 401(k) balances will be between 5 and 10 times as large as they are today. For these future retirees, 401(k) balances will represent one half to two times average "Social Security wealth" (the present actuarial value of future Social Security benefits) of $103,400. For households with heads retiring in 2035, the authors predict that 401(k) balances will be three quarters to two-and-a-half times Social Security wealth. To place the findings in context, the authors note that the expenses charged by the financial institutions administering 401(k) plans have a larger effect in reducing 401(k) balances at retirement than pre-retirement withdrawals do.

Predicting average 401(k) balances two or three decades into the future, the authors note, is "necessarily fraught with uncertainty." There could be systematic changes in household attitudes toward saving, or reforms of the Social Security system that alter the basic structure of financial preparation for retirement. The average retirement age could increase, boosting retirement assets. The authors assume that the increase in the rate of 401(k) participation will continue to rise for all age groups. Today's young and middle aged households have much higher 401(k) participation rates than current retirees did at similar ages. Those retiring in 2015 will have a participation rate 50 percent higher than those 55 years old in 1993 and retiring in the next several years, they predict.

-- David R. Francis