Many sponsors of 401(k) and other defined contribution plans have focused their educational efforts on how employees should invest their fund balances, but a far bigger problem needs to be addressed first.
That is the problem of preservation - educating employees to preserve their assets for retirement by rolling them into an individual retirement account or another qualified plan when they change jobs, rather than spending them.
As Dallas L. Salisbury, president of the Employee Benefit Research Institute, said in a recent speech, employees will lose far more retirement income by cashing out and spending their lump-sum distributions when they change jobs than they will lose by investing too conservatively.
Unfortunately, discussion of preservation was almost entirely lacking in most of the investment education programs entered in Pensions & Investments' Investment Awards competition last December.
Perhaps this is because employers fear scaring employees away from participation by strongly emphasizing that the money is for retirement savings and not for immediate consumption.
How big is the preservation problem? According to data from the Employee Benefits Research Institute, for 1993, the most recent year for which data are available, just 40% of individuals receiving lump-sum distributions from defined contribution and defined benefit plan reported rolling any of the money over. Only 25% reported rolling all of the money over. That means 60% spent all of the money.
In the four years ended 1990, some $200 billion in lump-sum distributions were not rolled over into IRAs or other tax-advantaged plans, according to EBRI's Mr. Salisbury. At the very least, this meant the individuals paid substantial tax penalties, which is leakage from their retirement savings. Of the remainder, even that which was saved is subject to further taxation on the interest or dividends earned. And a large part of the money not rolled over probably was spent.
The statistics show that the ones who would benefit most from the power of compounding - the youngest employees - are those least likely to roll over their assets.
For these individuals, the needs of today cry out to be met immediately. The needs of retirement seem far off, indistinct and postponable.
But often those immediate needs could be postponed, and would be postponed, if the employees were aware of the full cost of using all or part of their lump-sum distributions for current consumption.
One way to persuade members of defined contribution plans to roll over lump-sum distributions might be to show them the full cost of any purchase made from the distributions by adding in the penalty taxes paid and even the investment returns forgone.
Some way must be found to get the message across. Employees, especially young employees who are most prone to do so, cannot be allowed to continue to squander the opportunity to save for their old age.
Employers must begin to emphasize several key messages even before they begin to educate the employees on investing, namely:
Participate in the plan early;
Contribute significantly; and
Preserve the balance by rolling it over into an IRA when changing jobs.
Preservation is the most important. Without it, all of the others are in vain.