Smart Ways to Seal 401(k) Leaks

Jack Towarnicky

Jack Towarnicky previously served as executive director of the Plan Sponsor Council of America (PSCA). Towarnicky has over 40 years of corporate employee benefits experience, which includes leadership positions with four Fortune 500 companies. Towarnicky earned an LLM in employee benefits with honors from John Marshall Law School. His JD is from the South Texas College of Law, and he obtained an MBA and a BBA in business economics from Cleveland State University.

What job does your 401(k) perform? Why do workers “hire” your 401(k)? Why does the “customer” sign up for your 401(k)? Remember, 70% of workers live paycheck to paycheck,1 so why would they allocate precious take-home pay to your plan?

Almost all 401(k) marketing materials and mandated disclosures highlight retirement—accumulation and/or decumulation. Is that how most people use your 401(k)? The median tenure of workers ages 25 to 64 has consistently been less than five years for the past five decades2 —that’s 12 employers by age 50!3 So, most workers in your organization will become term-vested participants, not retirees!


Long ago, industry professionals recognized that America’s retirement savings plans were leaking, badly.

Almost all 401(k) plans allow cash-out at separation. In a March 2019 study,4 the Government Accountability Office found that workers ages 25 to 55 removed $69+ billion in 2013—a year marked by 18 million initial claims for unemployment benefits. According to the Investment Company Institute, retirement savings increased more than 60% between 2013 and 2019.5 Since 80+ million6 have filed initial claims for unemployment benefits in the last 12 months, it wouldn’t be surprising if leakage far exceeded $200 billion during that time!


Four times in the last four years, Congress authorized plan sponsors to make in-service withdrawals easier and in greater amounts—only once were lawmakers prompted by COVID-19:

  • The Bipartisan Budget Act of 2018 liberalized the rules for hardship withdrawals.
  • The SECURE Act (2019) offered new penalty tax-free withdrawal options for childbirth or adoption—up to $5,000 per parent and up to $10,000 per child.
  • The CARES Act (2020) eliminated any hardship requirement for qualified individuals; they could withdraw up to $100,000, avoid penalty taxes, and receive three-year income tax averaging and repayment options. Often, when one spouse qualified, so did the other—up to $200,000!
  • The Consolidated Appropriations Act (2021) added withdrawal provisions similar to CARES Act provisions if a participant’s principal residence is within a federal-declared disaster area (for economic losses between December 28, 2019 and February 25, 2021).

And, long before COVID-19, Congress created exceptions allowing savers to waive the 10% penalty taxes on premature withdrawals from IRAs—for higher education, first-time home purchases, unreimbursed medical expenses, and more.


Plan loans are not leakage unless they are not repaid—and almost 90% of all plan loans are successfully repaid.7 Loans are a valuable source of liquidity for those who are not creditworthy.8 Most defaults are on small amounts outstanding at separation, and many, perhaps most, employees would have cashed out their entire account anyway.

In my view, most plan sponsors added all of the above withdrawal features, some limit loans, but most haven’t updated their liquidity features. One unintended result from the widespread failure to update plan loan processing to 21st century functionality may be underutilization: 24% of eligible employees don’t contribute and another 30% don’t contribute enough to obtain the full employer match.9

Here are four changes that would reduce leakage and improve retirement preparation:

  • Add electronic banking to continue payments or even initiate a loan after separation.
  • Adopt a line-of-credit structure to make payments anytime and borrow only what’s needed.
  • Incorporate behavioral economics tools, concepts, and processes: have the participant execute the loan application as both the borrower and lender, have the participant share their banking information for payments in the event payroll deduction stops, and have the participant enter into a commitment “bond” to repay the loan regardless of employment status. 

Payroll deduction loan processing is so 20th century!

A fourth change would be to market and prioritize the enhanced loan functionality by concurrently eliminating hardship withdrawals and prospectively limiting other in-service withdrawals and post-separation, pre-retirement withdrawals.

These changes would allow term-vested and retired participants to gain access to tax-savvy liquidity instead of limiting those participants to distributions that are subject to income and/or early-withdrawal penalty taxes.

Remember, a loan’s principal remains in the plan as a fixed income investment. So, participants should reallocate as necessary to their target allocation. Where plan loan interest rates are lower than commercial loan rates and greater than bond investment returns, a plan loan can improve the participant’s household wealth and retirement preparation.


A few last items that can reduce leakage: 

  • Change the plan’s default at separation to “asset retention.”
  • Facilitate account aggregation/consolidation and “roll on,” whereby a participant’s outstanding loan(s) from an old employer is transferred to the new employer’s plan.10
  • Add “deemed IRAs” (Roth and traditional), which allow an employer to offer employees the ability to keep their IRA assets in the employer’s tax-qualified retirement plan. 
  • Add in-plan Roth conversion provisions (consider using plan loans to fund income tax withholding).
  • Add a directed brokerage option and/or Deemed IRAs for those who prefer other investments, annuities, etc.

Ultimately, the goal should be to ensure participants know that your 401(k) is capable of serving not only as a savings vehicle but as a separate legal entity, providing participants a lifetime financial wellness instrument.

1. “Getting Paid in America” Survey Results, National Payroll Week 2020, American Payroll Association, September 2020. About 70% of 30,000+ survey participants have, year over year, consistently confirmed that it would be very difficult or somewhat difficult to meet current financial obligations if the next paycheck was delayed one week. In the same survey in prior years, 85+% of the same workers confirmed that they were saving in their employer-sponsored savings plan.

2. Craig Copeland, “Trends in Employee Tenure, 1983–2018,” EBRI Issue Brief 474 (February 28, 2019). See also: Henry Hyatt and James Spletzer, “The Shifting Job Tenure Distribution,” IZA DP 9776 (February 2016).

3. “Number of Jobs, Labor Market Experience, and Earnings Growth: Results from a National Longitudinal Survey,” Bureau of Labor Statistics, Department of Labor (August 24, 2017).

4. “Retirement Savings: Additional Data and Analysis Could Provide Insight into Early Withdrawals,” US Government Accountability Office, Report to the Special Committee on Aging, US Senate (March 2019).

5. 2014 Fact Book, 54th Edition, A Review of Trends and Activities, Investment Company Institute. See also: 2020 Fact Book, 60th Edition, A Review of Trends and Activities in the Investment Company Industry, Investment Company Institute.

6. “Unemployment Insurance Weekly Claims,” US Department of Labor (February 11, 2021).

7. Timothy Lu et al., “Borrowing From the Future: 401(k) Plan Loans and Loan Defaults,” National Bureau of Economic Research w21102 (April 2015).

8. Geng Li and Paul A. Smith, “Borrowing From Yourself: 401(k) Loans and Household Balance Sheets,” Federal Reserve Board (2008).

9. “How America Saves 2020,” Vanguard.

10. Jack Towarnicky, “Stop Leaks: Plan Loans,” 401K Specialist, November 29, 2020.

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