Why do so many of us spend our retirement savings today instead of saving for when we’ll need it? The answer may come from our ancestors.
We’ve written before about how Americans aren’t doing enough to save for retirement. “Today’s workers face a major retirement income challenge,” according to the Center for Retirement Research at Boston College.
So given the already fragile state of American’s retirement savings, it’s obvious that if workers withdraw money from their retirement accounts for non-retirement purposes, they further compromise their retirement security.
To examine the impact of “leakage,” or the early withdrawal of retirement savings for non-retirement purposes, the Employee Benefit Research Institute (EBRI) conducted a series of simulations. The results confirm that taking money out of retirement savings for non-retirement purposes negatively impacts our ability to actually save enough for retirement.
In testimony to the ERISA Advisory Council of the U.S. Department of Labor in 2014, EBRI stressed that cash-outs, or taking cash out of a retirement plan when changing jobs, is the biggest concern, but loans and hardship withdrawals are problematic as well.
A 2013 study by Hello Wallet estimates that each year $70 billion of the $293 billion contributed to retirement plans exits for non-retirement purposes.
According to EBRI’s simulations, leakage is a problem that affects lower income earners harder. Twenty percent of those in the lowest income quartile who would otherwise have an 80 percent real replacement rate will fall short due to cash-outs at job change.
Why would someone jeopardize having enough money saved for a secure retirement by prematurely taking money out of their retirement accounts? The same reason countless experiments in human behavior map out our preference for $50 today over $100 a year from now. A quick calculation of the time value of money tells us $100 next year is worth more than the $50 today, but human tendency is to assign greater value to something immediately accessible than something available down the road.
Known as temporal discounting, this behavior explains how otherwise sensible people might tap dollars in their retirement accounts. For many of us, fulfilling immediate needs with a cash reward today far outweighs the future reward of adequate income replacement.
In defense of humanity, there was a time when temporal discounting was an evolutionary advantage. An early human that thought too far into the future might miss an immediate threat or opportunity. Pre-historic people learned to eat when food was available, hunt when game crossed their path, and paid attention to their immediate surroundings to avoid danger. These behaviors promoted the survival of early humans.
We carry these adaptations as hard-wired reflexes into the world today. But most of us will live much longer than early humans, and we have to think beyond the threat of the saber-toothed tiger. The only thing getting eaten is our retirement security.
If the temptation to tap retirement plans to address more immediate financial needs is hard wired, then policy changes designed to address the savings gap due to leakages must reflect an understanding of human behavior. Liquidity and personal control might encourage supplemental savings in 401(k) and Individual Retirement Accounts (IRAs) when defined benefit plans are available as a core source of income in retirement. As 401(k)s and IRAs eclipse defined benefit plans as the primary source of income in retirement, the ability to access retirement savings may set retirement security on a path to extinction.
