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What Can 401k Plan Sponsors Do to Discourage Unnecessary Premature Retirement Plan Withdrawals?

What Can 401k Plan Sponsors Do to Discourage Unnecessary Premature Retirement Plan Withdrawals?
May 05
00:03 2020

Is it enough to give someone enough rope, or are you also duty bound to stop that person from hanging himself? Far from merely being a philosophical conundrum, as fiduciaries, this is a question 401k plan sponsors ask themselves every day.

“The employer has a responsibility to provide a healthy retirement plan that needs its employees’ long-term needs,” says Ted Beal, Jr., Managing Director Retirement Benefits Group at Equitable in Edison, New Jersey. “Allowing hardship withdrawals without proper advice and consultation jeopardizes their employees’ ability to secure their financial well-being in retirement.

Of course, the easiest solution is to avoid it altogether. “Employers are not required to permit in-service withdrawals or loans,” says James T. Meredith, Senior Vice President & Financial Advisor at Hefren-Tillotson, Inc. in Pittsburgh, Pennsylvania. “We work with a number of employers who have decided not to permit any distribution prior to a separation from service.”

Still, many more plans do allow their employees to take hardship withdrawals. The CARES Act has made the option potentially more attractive. Which leads to the question:

Does the 401k plan sponsor have a fiduciary obligation to prevent an employee from hanging himself?

More important is the answer to “How?” Clearly, it comes down to communication. And where you’re talking communication regarding 401k plans, that can mean only one tactic.

“The main thing 401k plan sponsors can do is educate their participants,” says Michael Pappachristou, Wealth Advisor at RegentAtlantic in New York City. “Some individuals may view their plan as ‘found money’ in times of hardship, but should be made aware of the pitfalls that can come with early retirement plan distributions.”

The plan sponsor is the one responsible for handing out the rope. The plan sponsor therefore has the obligation that the employee uses that rope for good.

“For plans that permit loans and in-service distributions, education and financial counseling is critical,” says Meredith. “Employees may not have thought of cost saving exercises, may not be aware that other financial help exists, or may not fully appreciate the long-term cost of tapping into the retirement account.”

How should a plan sponsor reveal the future loss an employee will endure for satisfying a short-term need today?

“Reiterate the opportunity cost of taking a 401k distribution,” says Liam Hunt, a Toronto, Canada-based financial writer for Sophisticated Investor. “For every $5,000 withdrawn from your retirement account, you’re really costing yourself about $7,000 according to historical averages due to a combination of taxes owed on the funds and the gains those investments would have made if they had remained invested.”

The good news is 401k plan sponsors don’t need to treat this as a solo act. They’ve already got a team of hired hands to help them.

“Now more than ever, plan sponsors need to work with their fiduciary adviser to encourage significant employee education and offer the opportunity for participants to contact advisers for sound direction that is specific to their own personal situation,” says Jakob Loescher, a financial advisor at Savant Capital Management in Rockford, Illinois. “The ill-effects of a bad decision can have a lasting impact on a participant’s future if not reviewed carefully before action is taken.”

 

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Of course, there are options beyond talking a hardship withdrawal. “They could also educate participants on the ability to take a 401k loan especially in light of more relaxed rules,” says Frank Corrado Managing Director/Kevin Talty, CFP®, EA, Vice President Robertson Stephens Wealth Management, LLC in Holmdel, New Jersey. “For example, the maximum loan amount doubled from the lower of $50,000 or 50% of the vested account balance to $100,000 or 100% of the vested balance.”

But even this option comes with a severe price. And current events only augment the risk of realizing that penalty.

“Although some 401k plans allow participants to borrow against their plan balances, that may not be an ideal solution in this situation either,” says Macedon, New York-based Richard Barrington, a senior financial analyst for MoneyRates.com. “If you borrow against your employer’s 401k plan and then lose your job, you are likely to have to pay back that loan promptly or face tax consequences. Given escalating job losses due to the COVID-19 outbreak, this risk of borrowing against a 401k plan is heightened.”

The best answer to the “How?” question might be to look at the best practices employed by your peers.

“Most employers offer a robust set of tools and resources to help employees get on and stay on the right track to retirement security,” says Nathan Voris, Senior Managing Director of Business Strategy at Schwab Retirement Plan Services in Richfield, Ohio. “In fact, most 401k plans offer some type of personalized advice that can help workers look at their whole financial picture, which includes understanding how to work through difficult financial situations. Now is the time to remind employees about these tools and resources, so that they have the guidance they need to make the best financial decisions for their personal situation both short-term and long -term.”

Keep this in mind: ropes aren’t always bad. You need a rope to help you secure a shelter. And isn’t that the entire point of a 401k plan?

Christopher Carosa is a keynote speaker, journalist, and the author of  401(k) Fiduciary Solutions Hey! What’s My Number? How to Improve the Odds You Will Retire in ComfortFrom Cradle to Retirement: The Child IRA, and several other books on innovative retirement solutions, practical business tips, and the history of the wonderful Western New York region. Follow him on Twitter, Facebook, and LinkedIn.

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA

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