“America’s retirement system is sustainable” said no one, ever.
That’s the basis for my somewhat cynical reaction to a February 14th, 2022, Request for Information (RFI) issued by the DOL’s Employee Benefits Security Administration (EBSA). The RFI (Request for Information on Possible Agency Actions to Protect Life Savings and Pensions from Threats of Climate-Related Financial Risk) was issued pursuant to a May 20th, 2021 Executive Order, and asks respondents to identify climate change related threats to “the life savings and pensions of U.S. workers and families.”
While I believe in responsible, decisive actions to protect the environment and hope that the RFI yields substantive responses, I’m cynical because America’s retirement system has yet to directly deal with its own inefficiency and waste, and the resultant un-sustainability constitutes a far more serious, persistent, and quantifiable threat to future retirees than climate change ever could. That’s obviously true for Social Security and for defined benefit plans, but also applies to America’s 401(k) system.
If we were to adequately address the 401(k) system’s sustainability problems, we could produce far more of the “green” that will matter the most to future retirees.
A Lot to Celebrate, A Lot to Fix
To be fair, there’s a lot to celebrate about our 401(k) system:
- At least $7.3 trillion in assets, according to the Investment Company Institute (ICI)
- Over 600,000 employer-sponsored plans
- Approximately 96 million participant accounts in 401(k) private pension plans, including the Federal Thrift Savings Plan, which EBSA’s RFI included in its scope
- About 70 million active employee participants, presently contributing to their plans
These successes stand as a testament to the private sector and to policymakers who’ve maintained a relentless focus on expanding plan access and participation, increasing rates of saving and providing participants with easy ways to diversify.
Despite these successes, our 401(k) system displays clear signs of inefficiency and waste, which begin to manifest as soon as participants change jobs.
The most egregious example is rampant cashout leakage. Each year, at least 6 million job-changing participants – around 40% of the total – will cash out completely, squandering $92.4 billion in savings, according to EBRI. While some cashout leakage is to be expected in our voluntary 401(k) system, only about one-third of cashouts are due to a true financial emergency.
In addition to cashout leakage, there is an ongoing explosion of small-balance accounts, both in the 401(k) system and former 401(k) balances housed in dead-end safe harbor IRAs, as well as large and growing numbers of missing participants and uncashed distribution checks.
Unfortunately, these problems disproportionately impact those who can least afford it:
- The demographic segments that suffer the most from cashout leakage include minorities, lower-income workers, and younger age cohorts, all cashing out at much higher levels vs. the broader population.
- There is a ‘Great Divide’ between the outcomes of job-changing participants with balances greater than $15,000 vs. those with less than $15,000. While each category is roughly the same size in terms of numbers of participants, a 2017 analysis revealed that, 8 years following a job change, 79.3% of participants with balances over $15,000 had managed to preserve their retirement savings, while only 32.3% with sub-$15,000 balances had retained their savings.
The root cause of these ills is systemic friction and a lack of plan-to-plan portability, particularly with respect to small accounts. Put simply, it is very easy (and tempting) to cash out a modest plan balance in a former employer’s plan, but very difficult to move it forward to a current employer’s plan.
An Alternative Framework to “Green” Our 401(k) System
By contrast, seamless plan-to-plan portability would make consolidation the easiest choice, dramatically reducing the problem of cashout leakage, while simultaneously minimizing missing participants and uncashed checks.
In November 2021, the Brookings Institution’s Retirement Security Project released a paper, Small Retirement Accounts: Issues and Options, which explored the problems associated with small and inactive accounts, and came down squarely in favor of consolidation.
“Combining accounts” headlined the paper’s policy prescriptions, to be achieved by:
- Improving the overall plan-to-plan rollover (i.e., “roll-in”) process to include more “standardized, uniform protocols” which could “make it reasonable to require, for the first time, that all qualified DC plans accept rollovers.”
- Enhancing the automatic rollover of small balances to safe harbor IRAs, to allow the use of target date funds as default investments.
- “[S]upporting “automatic portability” rollovers between employer plans when employees change jobs.”
How Much Greener?
As a standalone policy initiative, EBRI estimates that promoting consolidation via auto portability for small balances would preserve $1.5 trillion, in today’s dollars. If extended to all balances, EBRI projects increased retirement savings of $2.0 trillion.
That’s a lot of green, but it’s just the start.
Other independent research by EBRI shows that promoting consolidation through seamless plan-to-plan portability makes virtually all public policies that would expand access or increase participation incredibly more effective, incrementally reducing overall retirement shortfalls by double digit percentages. For a sampling of the research, see here (ARPA), here (SECURE Act), here (various 2021 proposals), and here (Auto IRAs).
This connection between improved portability and an expanded, more efficient, and more equitable 401(k) system was clearly grasped by Derrick Johnson, President and CEO of the NAACP. When offering his recent endorsement of auto portability, Johnson linked auto portability’s adoption with the likelihood of an increased uptake of auto-enrollment, which he characterized as a “necessary strategy to address racialized inequities within retirement plans.”
The Most Socially Responsible Approach
I’m all for responsible actions that help to avert harmful climate change, and I’ll read the responses to the DOL’s RFI with great interest. However, when it comes to safeguarding Americans’ retirement security, I’m firmly convinced that efforts to make our 401(k) system itself more efficient, sustainable, and equitable for all participants represents a far more productive, actionable, and socially responsible approach.