While small-balance retirement savings accounts have fared poorly in the past, their future has never looked brighter. Real progress is being made in reducing their numbers while simultaneously preserving and consolidating their savings, vs. previous “solutions” that encouraged them to cash out or exiled them to dead-end safe harbor IRAs.
My optimism is based on large-scale, industry-led action on auto portability, and more recently, proactive steps being taken by leading providers to consolidate legacy small-balance IRAs, affording accountholders greater opportunity for a secure and timely retirement.
The Problem of Small-Balance Accounts
Missing participants, excessive cashout leakage, forgotten accounts and uncashed distribution checks are all sub-optimal participant outcomes closely linked with the proliferation of small-balance, inactive retirement savings accounts, which typically occur when short-tenured participants change jobs.
Each year, approximately 6 million defined contribution accountholders will change jobs with an account balance of less than $5,000. Of these:
- Only 6% of will proactively move their funds to another IRA or to a new employer’s plan.
- 55% will immediately cash out completely.
- 39% will have their balances automatically rolled over to a safe harbor IRA, exposing their savings to money market returns, predatory fee arrangements and barriers to exit.
- Every year thereafter, 6-12% of these safe harbor IRA accountholders will continue to cash out or allow fees to erode their balance to zero, and less than 1% will bother to move their funds out of the default investment fund.
In 2020, EBRI data suggested that there may be as many as 8.1 million legacy safe harbor IRAs, languishing in 100% money market funds.
Through industry-led action, the small-balance account dynamic is about to change for the better.
In October 2022, the retirement industry took decisive action, coming together in common cause to form the Portability Services Network (PSN), a network of the largest defined contribution recordkeepers dedicated to accelerating the adoption of auto portability.
As of this writing, the PSN network’s recordkeeper members represent over 63% of the defined contribution market, including approximately 82 million workers across more than 185,000 employer-sponsored retirement plans, with the network expecting to become operational this year. When operations commence, auto portability will begin to match inactive, small-balance accounts with active, current-employer accounts and will automatically transfer those accounts to a current-employer plan.
The power of auto portability, when combined with the reach of the PSN network, will produce nothing short of a revolution for future, job-changing participants whose small-account balances are subject to their plan’s automatic rollover provisions. For these participants, the best choice – consolidation – will also become the default choice, leading to dramatic reductions in cashout leakage and increased retirement security.
Helping Forgotten Accountholders
But what of those 8.1 million accountholders whose balances still languish in legacy safe harbor IRAs?
There’s good news here as well.
In July, a large recordkeeper announced a program to help small-balance IRA accountholders with lost or forgotten accounts. According to NAPA Net, the program will help “reconnect IRA holders with retirement funds they may have lost or forgotten. The consolidation of these accounts, which are often left behind when employees change jobs, will help IRA holders preserve and maximize retirement assets.” The recordkeeper noted that “[c]onsolidating these funds can make it easier to keep track of retirement savings and tap the power of long-term investment returns, ultimately putting savers on their best path to investment success.”
A Brighter Future for Small-Balance Retirement Accounts
In my view, these actions signal that the industry is not only committed to addressing small-balance retirement savings accounts on a go-forward basis via auto portability but is also pursuing solutions that deal with legacy issues created with the past use of traditional automatic rollover IRAs.
For small-balance retirement savings accounts, the future has never been brighter.