Financial Planning
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Many companies give new employees an automatic nudge to save for retirement. Like it not, you're enrolled in the company's 401(k) plan and have to opt out if you don't want to sock away money with every paycheck. To sweeten the pot, many companies match a portion of your contributions.
Auto enrollments are widely credited with boosting savings for retirement. But the nudge may be less effective than commonly thought; consistency, it turns out, matters far more in accumulating enough wealth to retire.
A recent academic study found that automatically enrolling new employees in 401(k)s increases net contributions by less than 1% of workers' income annually. That practice has become widespread since the Pension Protection Act of 2006 facilitated its adoption. Yet factors like job turnover temper its impact and the gains that may arise from automatically boosting participants' saving rate each year, according to the study, authored by researchers from Yale, Harvard, and the University of California, Berkeley.
Meanwhile, continuous savers have done quite well. Members of Gen X—born between 1965 and 1980—who have saved in the same plan for 15 years have an average balance of $554,000 versus $182,100 for Gen Xers overall, according to a recent report from Fidelity Investments.
Market volatility is frequently seen as an obstacle to savings, often causing nervous investors to retreat to cash. But the real culprits lie elsewhere.
A big hurdle for savings turns out to be job hopping. Many employees don't stay on the job long enough to accumulate much in their 401(k)s. Compounding the issue are vesting schedules that may prohibit workers from owning their full company 401(k) match until after a certain amount of time has elapsed. And when workers depart, a large number cash out their balance.
Other research also finds that workers tend to cash out when switching jobs. About 41% of workers withdraw funds from their 401(k) when leaving a job and of those, nearly 90% take out everything, according to a 2023 study by researchers at the University of British Columbia.
Younger participants are more likely than older participants to cash out, according to Vanguard. It might not seem consequential in your 20s if you only have a small amount saved. But much of the stock market's returns tend to come in a handful of days each year. Even a month or two on the sidelines can hurt your long-term returns, and it gets worse if you don't reinvest the money so it can compound over decades of your career.
Some companies don't make it easy on employees who leave. For balances under $1,000, 401(k) plans are allowed to force participants to cash out and send them a check. From $1,000 to $5,000, plans can forcibly roll you over into an IRA of their choosing if you don't specify what you want to do with the money.
But plenty of job-hoppers with higher balances take the money out: The cash-out rate is about 35% even for accounts between $10,000 and $20,000, according to the Yale, Harvard, and Berkeley researchers, who looked at behaviors across nine firms.
Missing out on market returns isn't the only drawback. You will owe ordinary income tax on the amount withdrawn from a traditional 401(k). If you are under 59½ years old, there's also an early-withdrawal penalty of 10%, unless you qualify for an exemption.
Unless you badly need the money, it's far better to roll over your 401(k) into an IRA. Above certain balances, many plans allow departed employees to leave their money in the 401(k) but make no further contributions. That can be a good option, especially in large-company plans that have very low fees.
There's a case for consolidation, though. Workers who change jobs frequently often have multiple, scattered 401(k)s as they approach retirement. Taking the time to roll each one into an IRA when you leave a job will make managing your finances easier and reduce the chances that you'll forget about an account.
What's more, a rollover gives you the opportunity to evaluate your fund choices and strategy. Investors often mistake having multiple funds for being diversified, when in reality they might hold similar underlying assets that closely track the S&P 500. Check your fund's performance against its benchmark, and consider switching to one with a better record if it has underperformed for a long stretch.
Hardship withdrawals are another matter, and Congress is making it easier to take money out for a hardship, by, for example, allowing participants to self-certify their need rather than requiring employers to verify it.
But using your 401(k) more like a piggy bank isn't a good idea unless you have tapped out other sources for a hardship or emergency. Staying the course really is the most effective way to save for retirement.
Don't Make This Retirement Savings Mistake. It Pays to Be Consistent.
Auto enrollments are widely credited with boosting savings for retirement. But the nudge may be less effective than commonly thought; consistency, it turns out, matters far more in accumulating enough wealth to retire.
A recent academic study found that automatically enrolling new employees in 401(k)s increases net contributions by less than 1% of workers' income annually. That practice has become widespread since the Pension Protection Act of 2006 facilitated its adoption. Yet factors like job turnover temper its impact and the gains that may arise from automatically boosting participants' saving rate each year, according to the study, authored by researchers from Yale, Harvard, and the University of California, Berkeley.
Meanwhile, continuous savers have done quite well. Members of Gen X—born between 1965 and 1980—who have saved in the same plan for 15 years have an average balance of $554,000 versus $182,100 for Gen Xers overall, according to a recent report from Fidelity Investments.
Market volatility is frequently seen as an obstacle to savings, often causing nervous investors to retreat to cash. But the real culprits lie elsewhere.
A big hurdle for savings turns out to be job hopping. Many employees don't stay on the job long enough to accumulate much in their 401(k)s. Compounding the issue are vesting schedules that may prohibit workers from owning their full company 401(k) match until after a certain amount of time has elapsed. And when workers depart, a large number cash out their balance.
Other research also finds that workers tend to cash out when switching jobs. About 41% of workers withdraw funds from their 401(k) when leaving a job and of those, nearly 90% take out everything, according to a 2023 study by researchers at the University of British Columbia.
Younger participants are more likely than older participants to cash out, according to Vanguard. It might not seem consequential in your 20s if you only have a small amount saved. But much of the stock market's returns tend to come in a handful of days each year. Even a month or two on the sidelines can hurt your long-term returns, and it gets worse if you don't reinvest the money so it can compound over decades of your career.
Some companies don't make it easy on employees who leave. For balances under $1,000, 401(k) plans are allowed to force participants to cash out and send them a check. From $1,000 to $5,000, plans can forcibly roll you over into an IRA of their choosing if you don't specify what you want to do with the money.
But plenty of job-hoppers with higher balances take the money out: The cash-out rate is about 35% even for accounts between $10,000 and $20,000, according to the Yale, Harvard, and Berkeley researchers, who looked at behaviors across nine firms.
Missing out on market returns isn't the only drawback. You will owe ordinary income tax on the amount withdrawn from a traditional 401(k). If you are under 59½ years old, there's also an early-withdrawal penalty of 10%, unless you qualify for an exemption.
Unless you badly need the money, it's far better to roll over your 401(k) into an IRA. Above certain balances, many plans allow departed employees to leave their money in the 401(k) but make no further contributions. That can be a good option, especially in large-company plans that have very low fees.
There's a case for consolidation, though. Workers who change jobs frequently often have multiple, scattered 401(k)s as they approach retirement. Taking the time to roll each one into an IRA when you leave a job will make managing your finances easier and reduce the chances that you'll forget about an account.
What's more, a rollover gives you the opportunity to evaluate your fund choices and strategy. Investors often mistake having multiple funds for being diversified, when in reality they might hold similar underlying assets that closely track the S&P 500. Check your fund's performance against its benchmark, and consider switching to one with a better record if it has underperformed for a long stretch.
Hardship withdrawals are another matter, and Congress is making it easier to take money out for a hardship, by, for example, allowing participants to self-certify their need rather than requiring employers to verify it.
But using your 401(k) more like a piggy bank isn't a good idea unless you have tapped out other sources for a hardship or emergency. Staying the course really is the most effective way to save for retirement.
