On the last day of 2023, a key provision of the SECURE 2.0 Act—increasing the limit on small 401(k) accounts subject to automatic rollovers into safe-harbor IRAs from $5,000 to $7,000—went into effect.
While a $2,000 increase may not seem like much on the surface, this development will make many more participants across the U.S. retirement system eligible for automatic rollovers if they don’t move and consolidate their 401(k) savings along their professional journeys. In concert with the ongoing expansion of access to employer-sponsored retirement savings plans, this has potentially very big consequences for plan sponsors and recordkeepers. Historically, balances under the automatic rollover limit are cashed out at much higher rates by participants within a year of switching jobs (55% on average) compared to all 401(k) balances (31% on average), according to data from the largest plan recordkeepers.
However, these trends do not need to be viewed negatively. While the number of small accounts subject to automatic rollovers does indeed rise, so does the number of participants who can benefit from the auto portability solution for moving and consolidating their 401(k) account balances at the point when they change jobs.
Auto portability is the routine, standardized, and automated movement of an employee’s retirement savings account (now with less than $7,000) from their former employer’s plan into an active account in their current employer’s plan.
According to Retirement Clearinghouse’s most recent Auto Portability Simulation (APS), a staggering 342.2 million job-changing participants will be subject to the forcible transfer of their stranded small accounts out of their former-employer plans into safe-harbor IRAs over the next 40 years. And, this will likely happen regardless of whether or not auto portability is adopted by plan sponsors nationwide during that 40-year span.
If participants are not aware that the small 401(k) accounts they left behind in former-employer plans are forcibly transferred into safe-harbor IRAs that earn little and deplete balances with fees, they could sue their former employers, who could be on the hook as fiduciaries.
However, the latest APS findings indicate that, thanks to the new $7,000 balance limit for mandatory distributions, many more participants will have the opportunity to preserve their retirement savings as they move from job to job. The APS estimates that over a 40-year period, the nationwide adoption of auto portability would lead to a $355 million reduction in the leakage of assets from the U.S. retirement system due to premature cash-outs (the vast majority of which occur when participants prematurely cash out their 401(k)s in former-employer plans after they leave for another job).
The expansion of access to workplace retirement plans, and to the benefits of auto portability, can help millions of Americans—including minorities and other under-served and under-saved workers whose prospects for a secure retirement are at risk due to premature cash outs—save more for retirement. Retirement Clearinghouse’s latest APS results estimate that an additional $1.6 trillion in savings would be preserved in the U.S. retirement system over a 40-year period if auto portability were to be adopted by sponsors across the nation. That sum would encompass $216 billion in extra retirement wealth for 30 million Black Americans.
New Year’s Resolutions for Plan Sponsors
To enable the higher number of job-changing participants subject to mandatory distributions to preserve rather than cash out their retirement savings, plan sponsors can undertake a few initiatives this year:
- Check to see that their automatic rollover programs are up to the task of accommodating the higher amount of small accounts eligible for mandatory distributions, and auto portability—which will move the accounts into the participants’ active accounts in current-employer plans, instead of just rolling them into safe-harbor IRAs. Plan sponsors should take the time to see if their rollover service needs to be updated or changed, and conduct thorough due diligence on any potential alternative providers.
- Communicate the benefits of auto portability and 401(k) account consolidation to plan participants. Preserving just one $7,000 401(k) account in the retirement system at age 25, instead of cashing it out, would cause the account’s balance to grow to $86,912 by the time the participant reaches age 65. Preserving one account with $7,000 at age 25, and another $7,000 account at age 35, instead of cashing them out would give the participant $133,213 by age 65. And, preserving three $7,000 401(k) accounts—one at age 25, one at age 35, and one at age 45—would give the participant $157,878 in savings by age 65.
The SECURE 2.0 Act has ushered in a new era in increasing retirement savings for millions of Americans. The power to make it possible is in the hands of plan sponsors—and the start of a New Year provides the perfect opportunity for sponsors to ensure they can accommodate the coming uptick in account rollovers and mandatory distributions.