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The Case for Automatically Moving Mandatory Distributions Forward

The mandatory distribution-to-Safe Harbor IRA plan feature as commonly utilized today was conceived in 2001 and launched in 2005 with good intentions, and for valid reasons. A mobile workforce, combined with a lack of retirement savings portability, had created a burgeoning problem for plan sponsors: an explosion of small-balance (less than $5,000) accounts left “stranded” in-plan, resulting in rampant cashouts, missing participants, uncashed distribution checks and the like. These problems only accelerated with the widespread adoption of auto enrollment, beginning in 2009.  

Mandatory distributions from employer-sponsored plans are a creation of regulation—specifically, a section of ERISA that allows plan sponsors to distribute accounts with less than $5,000 out of a qualified plan and into a safe harbor IRA. If plan sponsors follow the rules, they are protected from legal recourse, and the rules are simple: act in a fiduciary manner when choosing a provider for their program. However, that word—“fiduciary”—is often hard to define and can be interpreted in many ways, so it begs the question: “How does a sponsor best fulfill that responsibility in the context of a mandatory distribution program?”

In her 4/8/15 MarketWatch article, Alicia Munnell -- Boston College's Director, Center for Retirement Research -- comes down squarely in favor of a clearinghouse for the nation's 401(k) system, solving the dual problems of forced transfers (less than $5,000) and multiple retirement savings accounts. Ms. Munnell cites the efforts of RCH in developing workable solutions, as well as the progress made by Spencer Williams and Tom Johnson in advancing awareness and influencing public policy.

Mandatory distributions of small 401(k) accounts when participants separate from service provide many benefits for plan sponsors, including lower administrative costs and higher average account balances. However, these “automatic rollovers” also indirectly cause billions of dollars to leak out of the U.S. retirement system every year through cash-outs.