Jean Young, senior research analyst in Vanguard Center for Retirement Research, contends that participation rates pose a much bigger problem overall.“The number of people who aren’t participating in your plan is something sponsors should not overlook,” Young said. “Less than 4% of participants take a withdrawal—not their whole account, just a portion of it. Loans don’t really leak; they’re typically repaid. And when they do default, it’s usually a portion of the loan—not the full amount.”  

Young added: “But nearly 30% of eligible employees don’t have any retirement savings at all. Rather than the small amount of plan leakage from people that manage to accumulate some retirement savings, getting these nonparticipants into the plan should be of utmost importance.”  

Plan sponsors should be concerned any time participants take loans and withdrawals, she acknowledged, because they’re spending their retirement savings. But even if participants who take distributions haven’t accumulated enough savings to warrant doing so, the fact is that they still have more savings than those not in the plan. Also, loans and withdrawals provide some financial flexibility if a member of their household loses a job, or the participant is buying a home, paying for college, or covering an emergency medical expense. Even though plan leakage is an issue for sponsors, loans and withdrawals can help participants survive financial shocks—and their presence in plans can help boost participation.  

Increasing the plan’s participation rate should be plan sponsors' most important initiative—especially for those who have yet to switch from voluntary enrollment to automatic enrollment, Young contends. Twenty-four percent of Vanguard-recordkept plans with automatic enrollment have higher participation rates (82%) than those with voluntary enrollment (57%), indicating automatic enrollment is a plan design strategy that sponsors seeking to increase participation should strongly consider.

Her commentary explained that part of what's driving the plan-leakage concern is the fact that during the 2007–2009 market downturn, hardship and non-hardship withdrawals rose slightly. However, while loans declined during this period, they've recently returned to pre-downturn levels—perhaps because those who cut back during the downturn are now generally doing well enough to warrant an increase in spending.  

But even with the slight increase in loans and withdrawals, the numbers pale in comparison to the percentage of eligible, nonparticipating employees when considering all Vanguard-recordkept DC plans as of December 31, 2010. 

Vanguard data showed there were 11.5 loans per 1,000 participants in 2010—up just slightly from 11.3 in 2005. Only one in 10 loans default, typically when people change employers, and even then the default is on a portion of the loan, not the entire amount. It's important to remember that the presence of loans can solve liquidity constraints; employees who know they can access their cash in a pinch may be more likely to participate in the plan, the commentary said.   

According to Vanguard data, 3.7% of participants took a withdrawal in 2010. Although a very small percentage of participants took withdrawals, they are a bigger concern than loans—because most loans are repaid. Withdrawn money is out of the plan and can't return.