Impatience or Illiquidity? The Case of Early 401(k) Withdrawals

Abstract

A third of 401(k) participants cash out their balances when they leave their jobs. These pre-retirement withdrawals could arise from behavioral biases or liquidity constraints, but empirical evidence distinguishing between alternative explanations is lacking. Using a novel paycheck-level income panel covering millions of 401(k) participants, I show that workers who experience greater sub-annual income volatility are significantly more likely to cash out their balances at separation. The relationship between earnings volatility and cashout probability is conditional on annual income, driven primarily by negative earnings shocks, and most pronounced among low- and middle-income workers. The empirical results are consistent with a model in which workers use cashouts as a consumption-smoothing measure when income shocks deplete their liquid resources over the course of an employment spell. 

JEL Classification: D14, G50, G51, J26, J31, J32