Small to midsize businesses today are often encouraged to help employees improve their financial wellness, and for good reason. Financially struggling workers tend to have higher levels of stress and anxiety, which can lead to decreased productivity and an increased likelihood of errors. Some might even decide to commit fraud.
One key indicator of an employee facing serious financial trouble is “retirement plan leakage.” This term refers to the withdrawal of account funds before retirement age for reasons other than retirement. If your business sponsors a qualified plan, such as a 401(k), be sure you are at least aware of this risk — and strongly consider taking steps to address it.
Potential dangers
Some business owners might say, “If my plan participants want to blow their retirement savings, that is not my problem.” And there is no denying that your employees are free to manage their finances any way they choose. However, retirement plan leakage does raise potential dangers for your company. For starters, it may lead to higher plan expenses. Fees are often determined on a per-account or per-participant basis. When a plan loses funds to leakage, total assets and individual account sizes shrink, which hurts administrative efficiency and raises costs.
More broadly, as mentioned, employees taking pre-retirement withdrawals generally indicates there are facing unusual financial challenges. This can lead to all the negative consequences we mentioned above — and others.
For example, workers who raid their accounts may be unable to retire when they reach retirement age. So, they might stick around longer but be less engaged, helpful and collaborative. Employees not near retirement age may take on second jobs or “side gigs” that distract them from their duties. And it is unfortunately worth repeating: Motivation to commit fraud likely increases.
Mitigation measures
Perhaps the most important thing business owners can do to limit leakage is educate and remind employees about how pre-retirement withdrawals diminish their accounts and can delay their anticipated retirement dates. While you are at it, provide broader financial education to help workers better manage living expenses, amass savings, and minimize or avoid the need for early withdrawals.
In addition, one recent and relevant development to keep in mind is the introduction of “pension-linked” emergency savings accounts (PLESAs) under the SECURE 2.0 law. Employers that sponsor certain defined contribution plans, including 401(k)s, can offer these accounts to employees who aren’t highly compensated per the IRS definition. Additional rules and limits apply, but PLESAs can serve as “firewalls” to protect participants from having to raid their retirement accounts when crises happen.
Some companies launch their own emergency loan programs, with funds repayable through payroll deductions. Others have revised their plan designs to reduce the number of situations in which participants can take out hardship withdrawals or loans.
Pernicious problem
It is probably impossible to completely eliminate leakage from every one of your participants’ accounts. However, awareness — both on your part and those participants’ — is key to minimizing the damage that this harmful problem can cause. Your Rudler, PSC advisor can help you identify and evaluate all the costs associated with your qualified retirement plan, as well as other fringe benefits you sponsor. Contact us at 859-331-1717.
RUDLER, PSC CPAs and Business Advisors
This week's Rudler Review is presented by Kacie Hamlett, Staff Accountant and Matt Topmiller, CPA.
If you would like to discuss your particular situation, contact Kacie or Matt at 859-331-1717.
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