America is a fundamentally caring country, as reflected in the collective actions of its individuals, businesses and policymakers. In the midst of the COVID-19 crisis, no policy reflects this caring spirit more than the aptly-named CARES Act, which, among other things, temporarily allows retirement savers hard-hit by the COVID-19 crisis to tap their qualified retirement savings while avoiding the punitive, 10% early-withdrawal penalty.
The stakes have never been higher for the millions of Americans facing job terminations. Now, more than ever, we also need to redress the unfair burden routinely placed on the backs of millions of terminated plan participants who may soon be forced out of their plans and into traditional automatic rollover IRAs.
With balances less than $5,000, these participants tend to have less tenure, lower income and retirement savings levels. They’re also younger and are more-likely to be women and/or minorities. To these people – particularly in this time of crisis – every dollar, whether used for a financial emergency or preserved for retirement, matters greatly.
In many automatic rollover IRA programs, a decidedly unfortunate fate awaits many of them – but it doesn’t have to be that way, and you can make the difference.
We urge plan sponsors to take three actions to protect these participants:
- If you furloughed or laid off workers you intend to hire back, consider temporarily pressing the ‘pause’ button on your automatic rollover IRA program
- Understand the grim reality of traditional automatic rollover IRA programs
- Ask your recordkeeper to adopt auto portability, an enhanced standard of care for your automatic rollover IRA program
Action 1: If you furloughed or laid off workers you intend to hire back, consider pressing the ‘pause’ button on automatic rollover IRAs
For sponsors whose plans utilize traditional automatic rollover IRA programs (see action 2 below) and have experienced significant workforce reductions as a result of the crisis, think carefully about the frequency that you’re forcing out participants. If you’ve reduced your workforce with an intent to rehire these participants in the near future when the economy opens back up, you’ll be doing yourself and these participants a huge favor by temporarily pressing ‘pause’ on your automatic rollover IRA program.
During the pause, you might consider conducting missing participant searches to bring your participants’ records up-to-date. The combination of temporarily reduced participant mobility, along with a surge in distribution requests, could make this an opportune time to locate participants or beneficiaries.
Action 2: Understand the grim reality of traditional automatic rollover IRA programs
Most plan sponsors would be shocked to learn just how poorly their former 401(k) plan participants fare when they’re subjected to a traditional automatic rollover process.
Research reveals that very few of these participants – less than 7% -- will rollover their funds during the pre-force out window. A majority -- 60% -- will simply cash out, receiving no counseling about the high cost of cashing out.
The remainder will wind up in a safe harbor IRA, where – depending on their service provider – they can face predatory fees, including charges for account setup, address search, paper statements, annual maintenance (paid in advance), and so on. Very few (less than 1%) will bother to move their balance out of the default investment fund, where the provider may be skimming up to 350 bps from a fund they manage. As a result, your former participants’ balances will quickly decay.
Those former participants who wise up may learn that, in addition to the high fees, they also face significant barriers to exit (ex. – medallion signature guarantees).
The sad truth is, while safe harbor IRAs were always meant to be temporary, some service providers have found that presiding over large numbers of decaying, small balance IRAs is a very profitable, if not honorable, business model. So profitable, in fact, that many of these providers will pay one-time (and in some cases, ongoing) fees to recordkeepers, TPAs, advisors and even plan sponsors for directing these balances to them.
Unfortunately, it’s often difficult for plan sponsors to get all automatic rollover IRA fees and third-party arrangements fully-disclosed. You’ll have to be persistent and ask the right questions and even then, there’s no guarantee you’ll get a straight answer.
Action 3: Ask your recordkeeper to adopt auto portability – an enhanced standard of care for your automatic rollover IRA program
Auto portability, which is built on the chassis of the automatic rollover IRA, establishes an enhanced standard of care for small-balance, terminated participants who become subject to their plan’s automatic rollover provisions. Recordkeepers become members of a clearinghouse for small balance terminated participant accounts, resulting in a default process of moving these balances to the participant’s new employer plan upon job change – even if they return to their previous employer. Plan sponsors sign up for auto portability through their recordkeeper.
The key elements of the new auto portability “standard” include:
- Minimizing the time spent in a safe harbor IRA
- Eliminating the need to cash out balances less than $1,000
- Enhancing participant communication and disclosure, delivered during all phases of the process
- Formally integrating a robust address location search
- Establishing a transparent, simple & straightforward fee structure
Do You CARE?
In this time of crisis, plan sponsors can take actions that will deliver positive societal benefits. Show you care by temporarily pressing the ‘pause’ button on your automatic rollover program if you plan to rehire newly terminated participants, by understanding the grim reality facing most participants who are forced out of their plans under “traditional” automatic rollover IRA programs, and finally, by adopting auto portability – the enhanced standard of care for automatic rollover IRAs – through your recordkeeper.