Have you ever wondered why so few participants move their old 401(k)s into their current employers’ plans? Or why so many participants prematurely cash out their retirement savings accounts, regardless of taxes and penalties? Or why job-changing participants leave their savings behind only to lose track of them—as if their assets for retirement belong on some remote desert island away from all their other savings?
All of these sub-optimal—or, in the case of cashing out, just plain bad—decisions trace their roots to a common cause: the need for modern, innovative portability solutions to help participants when they change jobs. These include solutions that facilitate auto portability at the point of job change for participants with less than $5,000 in their accounts.
In his State of the Union address on January 12, President Obama spoke of this need for improved portability of retirement benefits. And on January 26, the White House announced proposals to help make Americans’ retirement savings more portable.
Why is the need so urgent in the first place?
Among the approximately 10 million Americans with 401(k)s who change jobs every year, consolidating savings in a new 401(k) ranks dead last in frequency—by a wide margin—of the four choices available to them. This result is true for all account balances, but when we examine the data for the two-thirds of job-changers with the smallest accounts[1], the evidence is even more compelling. The table below reports our review of the available industry data:
|
Small-Balance Distribution Decisions |
||
|
|
Low Estimate |
High Estimate |
|
Cash Out |
35% |
45% |
|
Roll to an IRA |
30% |
40% |
|
Stay-in-Plan |
20% |
25% |
|
Roll to New Employer Plan |
2% |
10% |
So why does a significant majority of participants take self-destructive actions, or do nothing, when these choices so clearly conflict with their long term retirement-saving goals? A groundbreaking research study from 2015 on mobile workforce behaviors, authored by Boston Research Technologies (BRT) CEO Warren Cormier, provides important clues:
Stay-in-Plan
Leaving 401(k) accounts behind in former employers’ plans is much better than cashing out, but can still lead to undesirable outcomes, including lost/missing accounts, and multiple accounts that are often poorly allocated. Nevertheless, participants’ inertia has saved them from making a very costly mistake (cashing out)—and positions them for lifetime participation in the U.S. retirement system.
Unhappily, the stay-in-plan option is not always available to the smallest-of-the-small-balance accounts—the 34% of annual job changers, an estimated 3.4 million participants, who have less than $5,000 saved at the time they change jobs. This group has to take some action, and research tells us that the cash-out rate for these participants approaches 60%!
Moving to a New Employer’s Plan
The difficulty and complexity of DIY plan-to-plan portability, particularly when compared to the relative ease of cashing out or simply doing nothing, leads many plan participants to make poor choices. Given these circumstances, the fact that roughly 50% of job-changers with small balances don’t cash out is a hopeful sign that their intentions are aligned with their long-term savings needs.
Cashing Out
It is commonly believed that participants cash out because they need the money. However, BRT’s research tells a different story, indicating that only one-third of cash-outs occur because of a participant’s need for emergency funds; said another way, cash-outs could be reduced by over 60% if more participants had access to solutions that made savings portability easier.
Cutting the Gordian Knot
One takeaway from the White House’s announcement is that it’s time for the industry to channel Alexander the Great, and cut its own Gordian Knot—the seemingly endless cycle of poor participant decisions that are leading to undesirable retirement outcomes—by introducing modern and innovative portability solutions.
Fortunately, progress is already underway within the retirement services industry. Understanding and awareness of the issues is way up, advocacy for new public policy solutions is growing, and adoption of portability practices—especially those that promote ongoing, proactive consolidation of savings in a participant’s current employer plan—is expanding.
Continual industry collaboration with lawmakers and public policy advocates, perhaps leading to a cooperative structure that enables the automatic, seamless movement of 401(k) savings as participants change jobs, can help improve retirement outcomes for millions of hardworking Americans.
[1] Small Accounts are defined as having less than $20,000 at the time of job change.