Avoid This Retirement Blunder When You Switch Jobs
Avoid This Retirement Blunder When You Switch Jobs
What happens when you can suddenly access your retirement nest egg?
Auto-enrollment is a feature in workplace retirement plans where employees are automatically signed up at a default contribution rate. Most people go with whatever the default option is, so by making the default option to save for retirement—more people will save for retirement.
This is a very good thing and a smart nudge for employers to help their employees save for retirement.
But what happens to your retirement savings when you leave your employer?
In this article, I’ll review research showing how people with strong present bias often squander their retirement savings when changing jobs—and how you can avoid that unfortunate fate.
Present bias makes us lazy and short-sited
This all has to do with a cognitive bias called “present bias,” which is the human tendency to choose immediate rewards and avoid immediate costs even if they know that those decisions are not in our best interest in the long run.
If you’re not familiar with present bias, don’t worry. I have you covered; here is a detailed post about how present bias impacts your finances:
A 2022 paper examined two ways present bias impacts our retirement savings.
Present bias causes procrastination. Employees who are automatically enrolled in their workplace retirement plan will stick with the plan, oftentimes because they are too lazy to opt out of the plan.
Present bias causes us to dip into retirement savings. When U.S workers leave an employer with a 401k, their 401k balances are often rolled over into an IRA account—which is easier to access before retirement.
Here’s a quote from the paper that sums it up perfectly:
“Distributions from an IRA are allowed for any reason, can fully deplete the IRA, and are penalty-free for some categories of spending3 or if the beneficiary is over age 59.5
Even when the standard 10% early withdrawal penalty does apply to an IRA distribution, households with sufficient present bias will be willing to partially or fully deplete these accounts before retirement.”
Translation: When you quit your job, and your 401k is rolled into an IRA, it becomes much more likely you will deplete your retirement savings before retirement—which you can blame on present bias.
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Liquidity is a double edge sword
Most people can achieve a successful retirement if they do two things.
Adopt a simple plan, and stick to it—Like contributing to a 401k
Don’t make catastrophic mistakes along the way—Like liquidating your IRA before retirement
Liquidity is a fancy finance term that describes how easy it is to convert an asset into cash.
Cash held in a bank account is the ultimate liquid asset, while physical assets like real estate and art are very illiquid. In terms of liquidity, retirement accounts like an IRA fall somewhere in between cash and a piece of artwork.
Being able to convert an asset into cash quickly is good in theory, as it gives you access to cash when you truly need it.
But, when you have strong present bias and an asset becomes more liquid—like moving from an employer 401k to an IRA—there’s a greater chance you’ll spend that money today even if you know that doing so might derail your retirement.
That’s how present bias causes us to make catastrophic mistakes.
If you are susceptible to present bias, having illiquid assets you can’t touch until retirement might be the best thing to happen to you.
In a previous article, I wrote about the phenomenon of the “wealthy hand-to-mouth.” These are high-income earners who spend every dollar they get their hands on. Despite having poor savings habits, the wealthy hand-to-mouth build a high net worth for two reasons.
They have forced or default savings through mortgage payments and workplace retirement contributions, often with auto-enrollment and employer match.
Their assets—real estate and workplace retirement plans—are illiquid, preventing them from spending their wealth away today.
Without addressing your present bias, owning illiquid assets might be a simple way to ensure you are building some kind of retirement nest egg.
Addressing present bias is an exercise in self-control
In my detailed breakdown of present bias, I explained that the best way to minimize the impacts of present bias is to learn financial self-control.
A 2021 meta-analysis aggregated the research of financial self-control strategies across 29 academic studies to determine how effective they were at helping people save more and spend less.
Self-control strategies are a broad concept and can include just about anything you might do to avoid the temptation to overspend.
The researchers focused on two strategies to increase financial self-control.
Proactive strategies which focus on what you can do to avoid tempting situations to overspend in the future.
Reactive strategies which focus on what you can do to avoid overspending once you are in a tempting situation to spend.
They found that proactive strategies tend to be more effective than reactive strategies.
Think of it like dieting. A proactive dieting strategy would be to avoid keeping any junk food in the house. By being proactive, you reduce your reliance on “willpower” to avoid temptation.
When saving money, think about situations where you will be tempted to overspend and think of a strategy to avoid that ahead of time.
Let’s say a group of friends want to go out for dinner. This is a prime situation where you will be tempted to overspend. To avoid paying marked-up costs at a restaurant, maybe you offer to host a dinner party and ask each guest to bring an individual item. Someone gets a bottle of wine, another person brings dessert, and you cook the main course.
That’s an example of a proactive strategy to practice financial self-control. Anticipate a situation where you will spend too much money and plan to avoid it.
The more you proactively plan to avoid situations where you can easily overspend, the less likely you’ll make a catastrophic mistake like draining your IRA to go on a vacation to Hawaii.
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.
In the UK you can't access these pensions until retirement even after moving jobs, short of a major life event like terminal illness. Seems a smart rule.