The Explosion of Small-Balance IRAs

Based on solid research, we’ve long known that typical automatic rollover IRAs result in high levels of cashout leakage. We’ve also suspected that they’ve contributed to an explosion of small-balance IRAs.
 
Now, new data from EBRI’s IRA database gives us a better understanding of the magnitude of the small-balance IRA problem that’s been fueled by automatic rollovers, as well as the sub-optimal retirement outcomes they can produce. This new information is yet another data point in favor of 401(k) consolidation via auto portability and could serve to inform future regulatory guidance, by expanding auto portability’s mandate to consolidate many of these ‘stranded’ safe harbor IRAs back into the 401(k) system.

The New Findings
EBRI’s analysis, presented in the Fast Facts Brief Losing Ground Safely: Small IRAs’ Large Stake in Money, examined EBRI’s IRA Database and found:

• Small account balance (< $5,000) IRAs make up over one-fifth (22.7%) of Traditional Rollover IRAs.
• These accounts are highly concentrated (76%) in money market investments.
• IRA accountholders include all ages, but the majority (55.6%) are ages 44 or younger.
• While many of these accounts have only been established recently, 27.2% were at least 7 years old.
• The asset allocation is not much different between those recently established and those established 10 years prior.
• Among young account owners of these small balance IRAs, the asset allocation is very similar.
  
  

In the brief, EBRI states that these small balance IRAs “can be attributed to a safe harbor regulation…with respect to the automatic force-outs of IRAs between $1,000 and $5,000” while adding that “[t]he result has been that a significant percentage of small IRAs are found to be invested 100 percent in money in Rollover IRAs.”

Extrapolating the EBRI Data
Using EBRI’s analysis, we can further derive a reasonable estimate of the total number of small-balance safe harbor IRAs via the following calculation:

• 46.4 million: Total households owning IRAs (source: ICI)
• 22.7%: Percentage less than $5,000 (source: EBRI)
• 9.6 million: Total Small-Balance IRAs (Calculation)
• 76.7%: Percentage Invested in Money Funds (source: EBRI)
• 8.1 million: Total Safe Harbor IRAs (Calculation)
  
  

That’s 8.1 million safe harbor IRAs, languishing in 100% money market funds.

How Auto Portability Can Help
Auto portability – by automatically consolidating small-balance safe harbor IRAs when participants change jobs – not only reduces cashouts but could address the explosion of these accounts and their sub-optimal participant outcomes.

The Department of Labor’s guidance on auto portability (specifically, Prohibited Transaction Exemption 2019-02) addressed the consolidation of all safe harbor IRAs established under the program but did not provide for the consolidation of pre-existing safe harbor IRAs. Now, with a better handle on the sheer magnitude of pre-existing safe harbor IRAs, perhaps it makes sense for the DOL to consider including these accounts within their framework.

When small-balance 401(k) savings can be successfully consolidated, participants win. That’s true when they avoid cashing out, but it’s also true when they avoid having their retirement savings ‘stranded’ in small-balance safe harbor IRAs.