Auto portability is a feature responding to the well-recognized trend in the U.S. of an increasingly mobile workforce. The Employee Benefit Research Institute (“EBRI”) has estimated that the average worker will have 7.4 jobs over their working career, which translates into an estimated 10 million workers with retirement accounts changing jobs each year. One of the decisions these workers need to make when changing jobs is what to do about their 401(k) retirement account. The choices are:
- Roll over to their new employer’s plan (“roll-in”) or to an individual IRA
- No action (i.e. leave in former employer’s plan)
- Cash out
The first two options have the advantage that they keep the participants’ account balance in a qualified retirement account which will contribute to their likelihood of a successful retirement outcome. Cash outs are obviously the least desirable course of action, contributing to the “leakage” problem (i.e. funds leaving the retirement system before retirement). A Federal Reserve Board study pegged the leakage rate at $0.40 of every dollar contributed to defined contribution accounts of participants under age 55. This high leakage rate does not bode well for the overall success of the retirement system.
To better understand the behavior and psychology underlying retirement plan distribution decisions, a study was conducted in 2015 by Boston Research Technologies (“BRT”), in collaboration with Retirement Clearinghouse, LLC, where 5,000 retirement plan participants were surveyed. Interestingly, the study found that cash outs when changing jobs was prevalent across all age groups (e.g. 34% of both Millennials and Gen-Xers and 24% of Baby Boomers had all cashed out at least one retirement account in their careers). Furthermore, about 75% of the cash outs involved accounts with a balance of less than $20,000, implying that participants may be more willing to cash out smaller account balances. Given the estimate of job changes by the average worker, this behavior is clearly detrimental to a participant’s retirement readiness.
Under current law, 3.4 million of the estimated 10 million workers with retirement accounts who change jobs each year (calculated by Retirement Clearinghouse based on EBRI data) have less than $5,000 in their account and, therefore, are subject to a mandatory distribution from their former retirement plan into a Safe Harbor IRA. According to the General Accountability Office in August 2009, almost 60% of these accounts are cashed out by participants, even though the cash outs are subject to taxes and penalties. In investigating the high cash out rate, the BRT study reported that participants found the roll-in process confusing and perceived it to be time consuming. These perceptions, along with the inertia behavioral bias of participants, likely contribute to the large number of cash outs.
The auto portability feature makes it easy for both employees and plan sponsors to move their retirement account balances when they change jobs. The need for this feature is evident based on the facts and circumstances noted above. Furthermore, half of the participants surveyed in the BRT study who had cashed out an account indicated they would not have done so had rolling-in been as easy as cashing out. This is what auto portability makes possible. Its benefits include:
- Reduced leakage – prevents leakage by automatically consolidating savings in a new employer’s plan, thereby systematically increasing overall retirement savings.
- Reduced duplicate accounts – minimizes cost from recordkeeping charges on stranded accounts or on account maintenance fees on a participant’s account when distributed into a Safe Harbor IRA.
- Reduced, lost or missing retirement accounts – makes it easy for participants to monitor their savings and reduces plan sponsor costs of tracking down missing participants.
- More appropriate long-term investment allocation – invests savings in the new plan’s default investment option, generally a professionally managed account.
Plan sponsors should consider investigating auto portability. While it currently is not that prevalent, given its benefits, the potential exists for it to become as ubiquitous as auto enroll. For this to happen, though, there will need to be some congressional and regulatory action to create the appropriate environment. Fortunately, recent activity in this regard has been encouraging.
To learn more about auto portability, please see Retirement Clearinghouse, LLC’s website – www.rch1.com.
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