Generous to a Fault? The Effect of Generosity of Employers’ Retirement Plan Contributions on Leakage from Cashing Out at Job Separation

Abstract

The US government imposes a 10% penalty to discourage pre-retirement leakage—cash withdrawal from 401(k) retirement savings before the age of 59.5. In our unique data set with 162,360 terminated employees covered by 28 retirement plans, 41.4% of employees leaked by cashing out 401(k) savings at job separation. We investigate the impact of employer matching contributions on leakage at job termination. Increasing the generosity of the employer/employee match rate increases retirement balances, reducing leakage. It also increases the proportion of one’s balance contributed by the employer, increasing leakage. We interpret the latter effect as showing that employees are more likely to frame their retirement accounts as a rainy-day fund rather than a lockbox of untouchable retirement savings when their employer contributes a greater proportion of the balance. We estimate that a 50% increase in employer/employee match rate increases leakage probability by 6.3% at job termination. However, there could be a 35.3% reduction in leakage probability if employees ignore the perceived incentive generated by the framing effect. Approximately 60% of accumulated assets from a 50% increase in match rate leak out of the system due to framing bias attributable to the percentage of assets contributed by the employer.