The numbers are staggering: a recent survey by FinanceBuzz revealed that almost 40% of Americans with 401(k)s opt for early withdrawals. Shockingly, less than one-third of them manage to repay any of the funds. [i] These withdrawals have far-reaching implications—not only depleting accounts but also undermining these individuals’ long-term financial security. As a plan sponsor, this is a significant concern on many levels. This article will examine things you can do to help stem the tide.

Understanding the Problem’s Scope

A large portion of the American workforce is already shockingly underprepared for retirement. Research by Prudential found that 67% of 55-year-olds fear they will outlive their savings. [ii] Early withdrawals exacerbate an already dire situation. Each time a participant withdraws funds prematurely, they not only typically face hefty taxes and a 10% penalty but also forfeit potential market growth. For instance, a $10,000 withdrawal at age 35 could mean missing out on roughly $40,000 in compounded growth by retirement age, assuming a 7% average annual return.

Moreover, the habit of early withdrawals can create a snowball effect, leaving participants habitually depleting their retirement funds rather than viewing them as untouchable reserves. For those already financially vulnerable, these habits can be devastating over time.

Many Participants Unaware of Recent Law Changes

As part of the Secure 2.0 Act tax law changes, the IRS now allows a one-time, penalty-free withdrawal of up to $1,000 from a retirement account per year for emergency expenses. This means that participants can now access a small portion of their retirement savings without incurring the usual penalties. In that recent FinanceBuzz survey, over 80% of workers reported being unaware of this provision. [iii]

While this new option has some conditions, this knowledge could possibly have helped some avoid larger withdrawals.

Strategies to Help Combat Early Withdrawals

While plan sponsors can’t control each participant’s actions, they do have a responsibility to help protect the interests of their workers. Drawing on our four-plus decades of experience in the retirement planning industry, where we’ve helped plan sponsors create better retirement outcomes, we’ve developed a range of strategies to support long-term savings. Here are some strategies to consider:

1. Educational Campaigns on the Topic

Since many participants are unaware of the new change allowing them to remove up to $1,000 annually for emergencies, simple one-time education on this topic might help prevent at least a few withdrawals. This and other proactive retirement plan education can help participants see the true cost of early withdrawals. Case studies illustrating compounded losses, such as how a $10,000 withdrawal today impacts future income, can be powerful motivators. Sponsors can use anything from simple emails or handouts to digital tools, videos, or interactive calculators to demonstrate how withdrawals harm long-term growth.

2. Enhance Auto-Portability to Reduce Cash-Outs at Job Change

Job transitions are one of the most common triggers for cash-outs. Many participants find the rollover process confusing or tedious and are tempted to take a payout. However, the industry’s latest auto-portability solutions, which automatically transfer a participant’s balance from one employer to another, can help. Sponsors implementing these features help reduce participant leakage at job changes, keeping retirement savings on track.

3. Maintain Competitive, Transparent Fee Structures

One lesser-discussed driver of cash-outs is participant dissatisfaction with fees. When participants perceive high fees or see lower-than-expected returns, they’re more likely to consider withdrawals. Fee benchmarking, a fiduciary responsibility that we regularly facilitate for our clients, can help ensure that plan fees are competitive. This, in turn, can enhance satisfaction and help minimize withdrawals. Participants who understand their fees are reasonable are often less tempted to cash out.

4. Offer Emergency Savings Plans

The lack of an emergency fund is a common motivator for early withdrawals. Sponsors can consider offering an emergency savings plan alongside retirement accounts, as authorized by Secure 2.0 Act tax law changes. [iv] This allows participants to set aside funds specifically for emergencies. When employees have an alternative to access for unplanned expenses, they’re less likely to tap into their retirement accounts.

5. Add More Financial Wellness Education

Many workers turn to 401(k) withdrawals because they lack financial literacy or budgeting skills. Sponsors can help combat this through financial wellness programs that cover budgeting and spending basics, debt management, and long-term planning. Programs should also address how to prioritize financial goals, with content addressing paying down high-interest debt, building emergency funds, and preparing for retirement without relying on early withdrawals.

Key Takeaway

The consequences of widespread 401(k) leakage cannot be overstated. For many workers, the result of frequent withdrawals is a retirement savings deficit. Some may eventually face working longer or significantly scaling back their retirement lifestyle. Plan sponsors who take steps to combat these cash-outs not only help participants build retirement security but also demonstrate their commitment to their fiduciary responsibility.