As Time Passes, The Gains Become Harder

By Thomas Hawkins | May 11, 2023

As Time Passes The Gains Become HarderAnyone of sufficient age who exercises regularly knows that gains become harder as you grow older. While improvements are possible, increased effort doesn’t always work. Instead, older fitness aficionados dial in the quality and efficiency of their workouts to experience continued gains.

Similarly, America’s 45-year-old defined contribution (DC) system has been wildly successful in increasing retirement security for millions of Americans – but is seeing new gains become increasingly difficult. Going forward, attempts to expand the system may produce benefits at the margin but should be paired with measures that increase the DC system’s quality and efficiency to maximize gains in retirement security.

Below is my “workout plan” for America’s defined contribution system.

Plug The Leaks
Cashout leakage is the #1 sign of inefficiency in the DC system, where over 40% of all participants prematurely distribute their balances following a job change. The tragedy of cashout leakage is that only around one-third of cashouts stem from a true financial emergency. Almost two-thirds of cashouts are for other reasons and could be avoided. Indeed, many participants experience high levels of regret over their cashouts, which grows over time.

According to EBRI, solving the problem of cashout leakage adds $2 trillion (in current dollars) to our retirement security. For $1.5 trillion of this amount, EBRI identifies auto portability (for balances less than $5,000) as the answer.

When it comes to plugging leaks, everyone seems to be getting on board the auto portability bandwagon, led by the five major recordkeepers who have announced participation in the industry-owned and led consortium, Portability Services Network, representing 71 million workers across more than 143,000 plans.

While auto portability addresses non-emergency cashout leakage, emergency savings could help stem leakage resulting from financial emergencies. SECURE 2.0 advances emergency savings through two provisions which, beginning in 2024, include: 1) emergency withdrawals of up to $1,000 per year and 2) allowing pension-linked emergency savings accounts, or PLESAs, to which non-highly compensated employees can contribute up to $2,500, indexed for inflation. There is, however, understandable concern that measures linking emergency savings to retirement balances might lead to more cashout leakage, as participants begin to view their retirement savings as a ready source of funds.

Consolidate the Balances
For those who manage to avoid cashing out, leaving behind a stranded account with a former employer or having a small balance forced out into a low-yielding safe harbor IRA is decidedly sub-optimal – particularly when you consider the added expense and difficulty involved in managing multiple accounts.

If you believe the answer to stranded & lost accounts will be found in the Retirement Savings Lost and Found registry, I have some bad news. While the measure might help some to locate legitimately lost or forgotten accounts, the database – absent any meaningful support for consolidation into existing accounts – could unintentionally trigger cashout leakage as participants go dialing for dollars.

“Consolidate the balances” is a mantra coined by former Plan Sponsor Council of America (PSCA) President David Wray, who was years ahead of his time when he wrote this piece in 2012. Back then, Wray recognized that account consolidation – where two or more accounts become one – is inherently efficient and has a protective effect on preserving retirement savings. By allowing, encouraging and facilitating roll-ins for new participants, plan sponsors can make a big difference in promoting consolidation.

(Smartly) Expand Access & Participation
Initiatives that expand access deliver undeniable benefits by increasing the ranks of retirement savers. However, in the absence of plugging leakage and promoting consolidation, they’re prone to massive inefficiencies, producing a tidal wave of cashout leakage and stranded accounts.

The reason is simple: the demographic segments who benefit most from these initiatives are the very same segments most likely to cash out or to frequently change jobs. Expanding access also creates a dilemma for plan sponsors, who must deal with the administrative hassles and increased costs from an explosion of small balance accounts, along with higher levels of missing participants and uncashed distribution checks.

The smart way to expand access and participation is to do so in tandem with enhanced portability and consolidation. That’s not just my opinion – below are direct links to EBRI research that calculated the incremental benefits of pairing auto portability with expanded access initiatives:

I could cite more, but I think you get the idea. Expanded access is good – but expanded access plus portability is a whole lot better.

Escaping the Law of Diminishing Returns
America’s DC system has an enviable track record of success, and there’s no reason to believe that it won’t continue to expand and prosper. However, the quality and degree of future growth it generates may depend on how well the DC system can skirt the law of diminishing returns.

A smart “workout plan” for the DC system would pair expanded access initiatives with measures that plug leakage and promote account consolidation, ensuring that continued gains are more easily secured.