Bank of America’s Q2 2023 Participant Pulse report, released in early August, surveyed the behavior of the more than 4 million plan participants in the bank’s recordkeeping clients’ employee benefit programs during the last quarter. While the average 401(k) account balance of these participants rose by 9.6% to $82,300 between the end of 2022 and June 30, 2023, the number of participants who made hardship withdrawals in Q2 2023 increased by a startling 36% year over year, to 15,950 participants.
Bank of America also reported that the number of participants who borrowed from their 401(k)s in Q2 2023 rose by 2.5% year-over-year, to 75,000 participants.
As I have discussed previously in this column, a plan participant’s 401(k) savings account should be the capital source of absolute last resort for meeting expenses. Even just one premature cash-out or withdrawal of a 401(k) account during a participant’s working life can have devastating consequences for their retirement readiness. A study undertaken by the Center for Retirement Research at Boston College found that early 401(k) withdrawals can reduce plan participants’ income in retirement, on average, by 25%.
Furthermore, under the SECURE 2.0 Act of 2022, plan sponsors will be given the option of automatically rolling terminated participants’ small accounts with $7,000 or less out of their plans, and into safe-harbor IRAs. This is an increase from the previous account-balance limit for these automated rollovers, which will remain $5,000 until December 31, 2023.
This SECURE 2.0 regulatory change will place a wider swath of small, stranded 401(k) accounts in danger of being automatically moved into safe-harbor IRAs. Our firm’s Auto Portability Simulation (APS) model, which utilizes data from the U.S. Department of Labor, large recordkeepers, and the Employee Benefit Research Institute (EBRI), estimates that 6.7 million participants with 401(k) account balances of less than $7,000 will change jobs in 2024. Furthermore, on a one-time basis beginning in 2024, 1.1 million small-balance, terminated participant accounts that have remained in their previous-employer plans could immediately become eligible to be moved into safe-harbor IRAs.
Like premature cash-outs, the move into safe-harbor IRAs can be detrimental for plan participants’ hard-earned retirement savings. If participants’ mailing addresses are not up-to-date in the files of former-employer plan recordkeepers, their automatically-moved accounts can languish and gradually dry up in safe-harbor IRAs.
Under the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001, which gave sponsors the authority to automatically roll terminated participants’ accounts with up to $5,000 into safe-harbor IRAs in the first place, the only default investment options permissible in safe-harbor IRAs are principal-protected products, which haven’t yielded much in returns due to the low interest rates of the past decade and more.
And, based on publicly available product information, many safe-harbor IRAs charge fees as high as $50 or more for annual administration,. For the $1,600 average account subject to a mandatory distribution, a 3% annual yield is required to keep the account from depleting. While yields on many principal-protected products used as default investments are yielding more than 3% today, that wasn’t the case for more than a decade before 2022, when interest rates began to move higher.
Bottom line, safe-harbor IRAs can deplete plan participants’ hard-earned retirement savings if their accounts wind up there.
Auto Portability to the Rescue
Sharp increases in 401(k) account withdrawals and small accounts eligible for automatic rollovers into safe-harbor IRAs spell trouble for plan participants. But these trends also spell trouble for sponsors and recordkeepers. As fiduciaries, they could be legally targeted by disgruntled terminated participants who were unaware that their accounts were automatically rolled over to safe-harbor IRAs years earlier, and have been depleted due to low returns and high fees.
Fortunately, sponsors and recordkeepers have access to a solution that can help them clean up their plans without automatically rolling terminated accounts into safe-harbor IRAs. Auto portability is the routine, standardized, and automated movement of an employee’s retirement savings account (with less than $7,000, as of December 31, 2023) from their former employer’s plan into an active account in their current employer’s plan. The solution functions within qualified plans’ existing platforms and data flows, and is underpinned by a “match” algorithm and “locate” technology that identify inactive accounts, find the accountholders, and initiate the process of moving those accounts into the participants’ active accounts in their current employers’ plans.
Auto portability also makes it possible to implement seamless plan-to-plan portability for participants at the point when they change jobs, so their small accounts won’t be left behind and become subject to automatic rollovers to safe-harbor IRAs.
This capability is more essential than ever, with 401(k) plan enrollment continuing to increase. Under SECURE 2.0, companies with new 401(k) plans will be required to automatically enroll employees at contribution rates of between 3% and 10%, beginning in 2025. The contribution rate at which employees are automatically enrolled will also increase by 1% annually, up to 15%.
Meanwhile, in another summertime development, Vanguard announced in June that the 401(k) plans for which it serves as recordkeeper achieved a record-high participation rate of 83%. Vanguard cited automatic enrollment as one of the key drivers of this milestone.
As a complement to automatic enrollment, auto portability can help sponsors avoid a plethora of small accounts that need to be cleaned out of their plans—optimizing plan metrics and participant outcomes. And as a complement to financial wellness programs (which can encourage participants to avoid withdrawing money from their 401(k)s to meet expenses), auto portability can encourage participants to transport and consolidate their savings when they change jobs, instead of cashing out.