WSJ Report: Investors Pull Money Out of Their 401(k)s

Jennifer Levitz of the Wall Street Journal [subscription required] writes in the journal dated 9/23/08, "Investors Pull Money Out of Their 401(k)s - Hardship Withdrawals Rose In Recent Months, Plans Say; Concerns About Tax Penalty."

With stocks falling, credit tightening and unemployment rising, small investors have been raiding their 401(k) accounts or slashing contributions to the popular retirement plans, according to the latest tallies of plan administrators. Others, eager to shield their portfolios from further damage, are reducing their exposure to stock mutual funds to near record lows.

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The behavior -- described by some market watchers as panicky in the past week -- has led to worries that the retirement prospects are dimming further for Americans, most of whom no longer have private-sector pensions to rely on.

Recent 401(k) winnowing is coming in the form of "hardship withdrawals" -- removing cash from the fund, with a 10% tax penalty, for exigencies such as job loss, the prospect of losing your home to foreclosure or a big medical expense.

T. Rowe Price Group Inc. in Baltimore saw a 14% increase in hardship withdrawals in the first eight months of this year, compared with the same time last year. Boston-based Fidelity Investments says the number of workers with hardship withdrawals rose 7% from April through June, compared with the same time period a year earlier. Principal Financial Group Inc., in Des Moines, Iowa, says that requests for hardship withdrawals are up 5% this year through Sept. 18, over last year, and that the withdrawal amounts are larger.

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Jim Wharton, a 65-year-old retired Sears Holding Corp. manager in Queen Creek, Ariz., says he moved his entire 401(k) balance of $357,000 to certificates of deposits insured by the Federal Deposit Insurance Corp. recently. The money had been invested in a "stable-value" fund, typically a low-risk, low-yield fund that invests in bonds and interest-bearing contracts backed by insurance companies. He says his next move may be "under the mattress."

According to Hewitt Associates Inc., a Lincolnshire, Ill., consulting firm, the total stock allocation among 401(k) participants is at a five-year low, declining to 62% in August from 68% a year earlier. Hewitt attributes the decline to an unusually high number of investors transferring money into fixed-income funds. It said it believes the trend continued into September.

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Ms. Schlesinger, the Providence investment adviser, says many workers who were too heavy on stock mutual funds going into the crisis have taken hits on their balance and now wonder what to do.

If they are young, she advises them to rotate slowly into more conservative investments -- to avoid selling their investments at a low price.

But, she says, if they are five years or less from retirement she is advising them to immediately protect their portfolio from further decline by moving at least 30% or 40% into fixed-income accounts. For many investors, that will mean "taking a loss," she says. She says, "I tell them, 'I'd like to think that the rescue plan is at the bottom of the market, but what if it's isn't? We can't gamble with that.'"

401(k) Participant Experience May Hold Lessons for Consumer Engagement in Health Plans

MarketWatch.com (via PRNewswire) reported today on an important new study published by the Employee Benefits Research Institute (EBRI) that seeks to apply lessons learned from evaluating the behavior of 401(k) participants into similar issues with health care plans. The study by Jodi DiCenzo, Behavioral Research Associates, and Paul Fronstin, EBRI (download full study - PDF- here) is summarized on EBRI's website. The Executive Summary is reproduced below [emphasis added]:

• Retirement and health benefits following a similar evolution: The private sector’s shift away from “traditional” company-financed pension plans toward individual 401(k) accounts illustrates how benefit decision-making and responsibility have shifted from the employer to the worker. The current trend in health care design toward “consumer-driven” health plans illustrates the same trend with health benefits.

• Health plan design is encountering the same obstacles as 401(k)s did: Efforts to make workers more involved and responsible for their health benefits have run into the same problems that 401(k) plans did: Workers tend to delay or be disengaged from both retirement and health care decisions, these issues require long-term planning, and workers see both retirement and health care decisions as complex and difficult.

• Worker behavior is driving retirement plan design: Enactment of the Pension Protection Act of 2006, which encouraged the use “default” 401(k) enrollment and investment decisions and simplified choices, represents the strongest federal endorsement of retirement plan design based on worker behaviors.

• Behavioral research can help employers design health benefits: This report looks specifically at lessons learned in the retirement realm with respect to offering workers choice, financial incentives, and more information and education. This is compared with the early evolution of consumer-driven health plans, which are still being driven solely by the market and not by legislation.

• Among the behavioral lessons learned from retirement plans:

--> More choice is not always better: Behavioral research, particularly with 401(k) retirement plans, has shown that increased choice can have negative consequences: More is not always better and may even be worse in some cases. Many people remain disengaged from matters they do not have an immediate need to address, and by the time the need becomes immediate, it is often too late. Many, if not most, workers are probably not capable of making the most appropriate retirement planning or health care choices—it is simply too difficult.

--> Education and information are not enough: Research has shown that education has resulted in little to no improvement in workers’ knowledge of retirement saving and investing. In addition, empirical evidence suggests that even when “educated” employees know, most of them fail to act on their knowledge. The heavy investment that many employers have made in retirement education and information programs often fails to produce the desired results.

--> Financial incentives don’t always work: Financial incentives, such as an employer match in a 401(k) plan and tax breaks, also fall short of motivating optimal behaviors. Despite the tax-favored status of contributions and the existence of employer matching contributions, a significant portion of eligible workers still do not contribute to a 401(k) plan.

• Careful plan design more likely to succeed: Employers can effectively overcome many of these challenges with effective retirement and health plan design. Research has shown how default choices, simplification, framing, and requiring active decisions in 401(k) plans can go a long way toward improving the decisions that workers make. Similar design factors can be applied to employment-based health plans, and plan sponsors are well advised to determine these potential effects ahead of time.