Protecting benefits owed to a company’s current and former employees is the cornerstone of an employer’s fiduciary duty under ERISA, which celebrates its 50th anniversary this year.
So, it troubles me when I read about strategies for plan optimization that advocate for continued reliance upon “old-school” automatic rollovers. While I am all-in for plan optimization, old-school automatic rollovers put employee benefits at risk by generating massive amounts of cashout leakage, stranding millions of participants’ balances in safe harbor IRAs that charge excessive fees and earn paltry returns, while disproportionately impacting minorities, women, low-income and younger workers.
While old-school automatic rollovers have one foot in the past, automatic rollovers that incorporate auto portability are the way of the future, with the industry-led Portability Services Network leading the way forward. They not only dramatically reduce cashout leakage, but they greatly minimize – or in some cases, virtually eliminate – the time job-changing participants spend in a safe harbor IRA.
Where Old-School Automatic Rollovers Fall Short: Cashout Leakage
While it is valid to say that old-school automatic rollover programs have helped plans mitigate a portion of their cost and risk, the truth is that they have negatively impacted many participants’ ability to properly save for retirement.
Based on industry data, of the 6.2 million annual job-changing 401(k) participants whose balances are subject to their plan’s automatic rollover provisions:
- 55% immediately choose the easiest option and cash out completely, receiving no counseling to discourage this behavior and no assistance to move their retirement savings forward.
- Only 6% proactively move their funds to another IRA or to a new employer’s plan.
- The remaining 39% do nothing, and have their balances forced out into a safe harbor IRA and invested in a money market fund, where only 1% bother to move out of the default fund.
- Ongoing, 6-12% of these accountholders will cash out each year or will eventually allow fees to erode their balance to zero.
Over a multi-year period, upwards of 70% of these former participants will cash out entirely, translating into 4.5 million annual participant cashouts.
For old-school automatic rollover programs, high levels of cashout leakage are undeniable, as evidenced by numerous leakage statistics published by large recordkeepers that associate higher cashout leakage rates with the lowest balance segments. While automatically cashing out balances below $1,000 exacerbates the problem, the customary practice of sending distribution forms with termination notices for balances subject to mandatory distributions reinforces the message to participants that they should take the cash.
Ironically, those cashing out early may fare better than those who preserve their savings, only to wind up in a safe harbor IRA. In October 2020, EBRI research indicated the existence of 8.1 million unclaimed safe harbor IRAs – a massive “landfill” of dormant balances still under-invested in a default money market fund. During the zero-interest rate environment that prevailed for most of the last decade, fees eroded many of these accounts. On principle, while modest account fees are necessary to adequately service small balance IRAs, some providers have mined these accounts with a line-up of fees that test the limits of reason.
An internet search reveals actual safe harbor IRA fees that include:
- Initial setup fees, of up to 20% of the initial balance
- Annual maintenance fees paid up front
- Use of prepaid cards for distribution payments
- Account closure fees in addition to distribution fees
- Recurring search fees, if an accountholder is deemed missing (over $100 per search)
- Paper statement fees (up to $15 per mailing)
- Escheatment fees ($125 per account)
- Residual dividend distribution fees
- Check reissuance fees
- Roth conversion fees
- Federal Thrift Savings Plan rollover fees
While for some, old-school automatic rollovers have represented an outstanding revenue model, those revenues were drawn from the retirement savings of those who can least afford them, and it is a model that plan sponsors should abandon in favor of auto portability.
The Truth About Auto Portability
First, auto portability dramatically reduces cashout leakage by making the best choice (portability) the default choice for affected participants. There is a plethora of research that supports this contention, and none that refutes it. In 2019, EBRI published Issue Brief No. 494, which pegged the present value of additional retirement savings accumulations from auto portability at $1.5 trillion, for accounts under $5,000.
Second, auto portability – as implemented by the industry-led Portability Services Network – seeks to minimize the time that any job-changing participant must remain in a safe harbor IRA. Under auto portability, in many plan-to-plan transfers, a safe harbor IRA merely serves as a transitory “conduit” to move savings from one plan to another.
Third, even participants whose safe harbor IRA accounts did not originate from a plan that has adopted auto portability can benefit from the PSN network’s locate-and-match abilities. If their current employer’s defined contribution plan account is located within the PSN network, at Retirement Clearinghouse they are given the opportunity to consolidate their safe harbor IRA balance, albeit on an affirmative consent basis.
Finally, auto portability delivers all the plan optimization features of old-school automatic rollover programs but goes one key step further. Plan sponsors participating in auto portability will receive automatic roll-in contributions for new employees whose eligible balances are located and matched to their current employer’s account.
The Fate of Old-School Automatic Rollovers?
I believe that the retirement industry, embracing innovation and acting in the spirit of ERISA mandates, will quickly shift from old-school automatic rollover programs to automatic rollover programs that incorporate auto portability delivered via the Portability Services Network. As a result, participant outcomes will improve, and the retirement industry will become healthier in the long run.