Beware of Second Order Effects for Retirement Savings Public Policies

By Thomas Hawkins
Published on September 1, 2021

Second Order EffectsAt first glance, some retirement savings public policies can seem like a sure thing, particularly when they’re based solely upon the benefits that would directly result. However, in the real world, these “first order” effects are inevitably followed by “second order” effects, which can sometimes be antithetical to the policy’s original intent.

The current pipeline of retirement savings policy initiatives – particularly those that dramatically expand access to, or participation in, workplace retirement savings accounts – claim some very impressive benefits. But what might their unintended, second order effects be? If we can reasonably forecast some of the undesirable effects, how might we address them?

The Second Order Effects of Expanding Access & Participation
In a Senate Finance Committee hearing held on July 28th, Senators were stunned by figures presented by Brian Graff, Chief Executive Officer of the influential and highly regarded American Retirement Association. Citing two policy initiatives – the Automatic IRA Act and the Encouraging Americans to Save Act (EASA), Graff informed committee members that these policies could generate an incremental 51 million savers and yield an additional $6.2 trillion in retirement savings, over 10 years.

While I have every reason to believe Graff’s figures, I am reasonably certain that, all other things equal, a dramatic expansion in both workplace retirement plans and participation levels would also give rise to equally dramatic increases in:

  • Cashout leakage, which is currently estimated by EBRI to be $92.4 billion per year and affects around 40% of all job-changing participants
  • Missing participants, caused by – among other things – one in every five relocations
  • Lost or “stranded” accounts, where 1 in 5 participants eventually learn of a retirement savings account they didn’t realize they had
  • Uncashed distribution checks, which frequently occur following mandatory cashouts of balances less than $1,000

Taking my thought experiment one step further, if you accept that significant increases in these effects are likely second order outcomes, then it’s not inconceivable that existing sponsors of 401(k) plans (particularly those in high turnover industries) could see their plan costs and fiduciary risk levels rise significantly as well. In some cases, they may rise to the point that some sponsors may opt to discontinue an “expensive” 401(k) plan in favor of a government-sponsored automatic IRA, if that option is available.

What to Do?
To be clear, I am firmly in favor of public policies that expand access and participation – I simply believe that we should recognize their likely second order effects and take steps to address them.

A prime example of what not to do would be to address cashout leakage by prohibiting pre-retirement 401(k) withdrawals altogether, or somehow further restricting early withdrawals (ex. – by increasing penalties, or by extending the penalty age from 59-1/2 to 62). High-profile proponents of these policies argue that our 401(k) system is fundamentally flawed in allowing early withdrawals to occur at all. However, combining restrictive withdrawal policies with expanding access could ultimately be self-defeating, as erecting barriers to exit would have a chilling effect on participation and deferral rates.

A much better solution is to facilitate plan-to-plan portability for job-changing participants. Facilitating portability evens the scales for job-changers by making portability easy – and in the case of small balances – super easy via auto portability.

Extensive research confirms auto portability’s benefits, to the entire retirement system, as well as specific demographic segments. By consolidating accounts, auto portability could significantly reduce the incidence of missing participants by reducing the number of accounts most prone to going missing. Finally, if there were legislation that incented the adoption of auto portability, the strong alignment with policies that expanded access & participation would generate even greater policy benefits than those policies alone.

The Way Forward
The ideal way forward is to adopt smart public policies that expand access and encourage greater participation, but also effectively address the persistent problems of cashout leakage, missing participants and stranded accounts.

The good news is that these problems can be largely minimized through policies that facilitate portability. Even better news is that the one solution with the greatest potential impact – auto portability – is now moving towards widespread adoption.