Why Is There So Much Pre-Retirement Liquidity in the U.S. Pension System?

Some analysts argue that there is a retirement savings crisis in the United States. While the extent of the crisis is contested, most analysts agree that retirement savings in this nation is inadequate. Although the reasons for the retirement savings shortfall are many and complex, this paper focuses on one factor that leads to inadequate retirement savings in the United States: pre-retirement liquidity or leakage.

Pre-retirement liquidity or leakage refers to the ability of individuals to withdraw money from their retirement savings account prior to retirement and use that money for nonretirement purposes. The Employee Benefit Research Institute (EBRI) writes, “A recurring issue with defined contribution (DC) savings plans such as the 401(k) is the risk of ‘leakage’—preretirement reductions in plan savings by workers, either through loans, hardship withdrawals, or payouts at job change.” The United States is unusual in the level of pre-retirement liquidity it permits. This article explores why the United States permits so much pre-retirement liquidity.

The article begins by discussing the role the U.S. government plays in encouraging retirement savings. It discusses the principal forms of pre-retirement liquidity in the U.S and the evolution of the law governing pre-retirement liquidity in the U.S. It then compares the level of pre-retirement liquidity permitted in the United States with that of other nations. Finally, it explores why the United States permits so much more pre-retirement liquidity and what might be done to reduce liquidity and enhance retirement savings.