Plan Design Is One Way to Stanch Outflows

Retirement readiness is the loser when participants take distributions before retirement, says BMO Retirement Services in a white paper.

In its nine-part educational series for plan sponsors, BMO shines a light on retirement plan issues including plan design and operational efficiency. The series is designed to assist plan sponsors cost-effectively help participants gain the most from their 401(k) plans.

The third paper in the last section, just released, deals with participant utilization, addresses plan leakage and ways plan sponsors can stanch outflows. Other topics in the section were participation, contributions and investing behavior.

Auto features—enrollment, escalation and easily implemented investment options—can help guide participants along their way to a successful retirement, the paper notes. But addressing plan leakage from loans, in-plan distributions and cash-outs also plays a part.

Plan participants contribute about $175 billion to their retirement accounts each year, which is matched by an additional $118 billion in employer contributions, according to a HelloWallet study. Unfortunately, BMO notes in its paper, participants take an estimated $70 billion in non-retirement withdrawals each year—an offset of nearly 26% against current contributions.

Even though loans taken from a 401(k) plan are generally repaid by the participant, BMO believes they should still be viewed as plan outflows. Loans are issued to participants in pre-tax dollars but are repaid with after-tax dollars, the paper points out. And after the participant retires, those dollars are taxed again when distributed from the plan.

As a result, the Employee Benefits Research Institute (EBRI) projects an erosion of retirement income of 10% to 13% for those participants who stop contributing during the loan deferral period. Despite this threat to retirement readiness, nearly 20% of participants have an outstanding balance at any point, and about 40% of participants initiate at least one loan over any five-year period, according to research cited by BMO.

“While the causes of the outflows from 401(k) plans are important, the actions plan sponsors can take to prevent them are critical,” says Todd Perala, director of strategic initiatives in retirement and trust services of BMO Global Asset Management and the paper’s author. “The steps we recommend to clients include restricting participants to single loans for serious hardships only. After hardship withdrawals, sponsors should consider automatically restarting participant contributions.”

Perala also recommends that plan sponsors be frank in their communications about the negative impacts of plan loans, hardship withdrawals and cash-outs. “If possible, sponsors should amend their plans to allow for partial distributions by participants at retirement and permit new employees to roll over existing loans from prior providers,” he says.

BMO clearly outlines the three main types of plan leakage or outflows:

  • Loans: The leading cause of loan-related outflows are employees separating from plans; and more than two-thirds of participants with outstanding loan balances opt to take cash distributions rather than repay the loan. Even if repaid, these researchers believe 401(k) loans should be considered outflows as they are issued pre-tax, but repaid in post-tax dollars.
  • In-plan distributions: While plans allow hardship withdrawals, such outflows are often accompanied by a suspension of contributions for six months. This suspension, coupled with the opportunity cost of the initial hardship withdrawal, can result in participants losing a large portion of their retirement security.
  • Cash-outs: These are perhaps the most common outflow source and typically occur when participants leave their employer. Rather than rolling their retirement savings into an IRA or their new employer’s defined contribution plan, they opt for a cash distribution. This option typically subjects participants to taxation and a possible 10% IRS penalty.


BMO offers simple steps to limit leakage that could benefit participant outcomes:

  • Restrict loans: Allow one loan at a time, for serious financial hardships only.
  • Negotiate with the service provider: Allow participants to make loan repayments after they separate from service.
  • Automatically restart participant contributions six months after issuing a hardship distribution.
  • Develop targeted communications: Address the negative impacts of in-plan loans, taking hardship distributions and cashing out of the plan.
  • Amend the plan: Allow partial distributions by plan participants and permit new employees to roll over existing loans from prior providers.


“BMO Defined Contribution IQ: Outflows” can be downloaded from BMO’s website, where links and information about the other papers in the series are available.