Chapter 7. Limit Leakage
Continuing with our theme of the shortcomings/opportunities in the defined contribution (DC) system as it currently operates, in this chapter we will address some of the ways in which assets can leak out of the system. This happens because when workers participate in DC plans, they sometimes tap into their accumulated savings prior to retirement. Some cash out a lump-sum distribution for nonretirement purposes. Some use them as security for a loan that the participant receives from the plan. Some take what are known as "hardship distributions" from their accounts. We will follow a similar structure to the previous chapter and consider for each of these forms of leakage the extent of the issue and the reasons. Because the possible solutions are essentially the same in all cases, we will address them together.
As we mentioned in Chapter 6, it may be that some participants, particularly the low-paid ones, use these leakage features as a way to make contributions to DC plans, get an employer contribution match, and then effectively take back their own contributions because they really can't afford to save. To that extent, they are less likely to respond to the solutions we discuss.
When workers change employers, they sometimes choose to withdraw—or "cash out"—their retirement savings account. Since taking money out before retirement is not really the point of a retirement savings vehicle, the tax system is designed to discourage this: Preretirement ...