How proposed legislation can help resolve retirement-savings gaps

Vanguard's How America Saves report for 2022 provided cause for optimism with some of its findings. For example, employee participation rates in Vanguard-managed defined contribution plans remain high, and have not declined year-over-year during the pandemic. The majority of participants in Vanguard plans also increased or maintained their contributions last year, and the average account balance for Vanguard participants increased by 10% year-over-year to $141,542. 

However, the report underscored that premature cash-outs of small 401(k) balances continue to threaten retirement readiness for plan participants, especially those who are younger and have less savings. Vanguard noted:

"Most participants with 401(k) balances of less than $1,000 voluntarily or are automatically cashed out of their retirement savings when they leave an employer compared to just 7% of participants with balances over $100,000. Participants who prematurely cash out their retirement savings risk immediate tax consequences, and may forfeit future savings and returns if assets are not reinvested in a tax-sheltered account."

Read more: What the Pension Protection Act has taught us about saving for retirement

Vanguard also stated that, to resolve this issue, "Auto portability services and revisions to minimum balance rules can help decrease cash-out rates." 

Auto portability is the routine, standardized and automated movement of a retirement plan participant's 401(k) savings account from their former employer's plan to an active account in their current employer's plan. Auto portability was conceived and built to meet the needs of plan participants with account balances of less than $5,000, who often lack access to the portability solutions afforded to their counterparts with larger accounts.

Shortly after Vanguard issued this year's How America Saves report, Sen. Tim Scott (R-S.C.) and Sen. Sherrod Brown (D-Ohio) introduced the Advancing Auto Portability Act of 2022, which would enact measures to enable and encourage the adoption of auto portability by plan sponsors and recordkeepers nationwide. 

This proposed legislation would make it much easier for plan participants to transport and consolidate their 401(k) savings balances at the point when they change jobs, helping them avoid the destructive decision to cash out. On average, cashing out 401(k) account balances prematurely can decrease a participant's 401(k) savings for retirement by 25%, according to Boston College's Center for Retirement Research. 

Read more: Amidst the Great Resignation, retirement-savings portability is more vital than ever

But minorities and low-income workers are disproportionately more likely to make this decision after they change jobs. The Employee Benefit Research Institute (EBRI) has found that 14.8 million plan participants switch employers every year, and according to data from the largest plan recordkeepers, nearly one-third (31%) of them will cash out their 401(k) account balances from their prior-employer plans within a year of their employment change. 

This cash-out rate within a year of job-change is higher than average for plan participants who are minorities (63% for Black Americans, and 57% for Latinos), earn $20,000 to $30,000 in annual income (50%), or are between ages 20 and 29 (44%). It is also higher than average for women (41%), and especially those who are aged 25 to 34 (71%). 

EBRI estimates that the nationwide adoption of auto portability would preserve up to $1.5 trillion in additional retirement savings, measured in today's dollars, in the U.S. retirement system over the course of 40 years. That sum would include approximately $191 billion for 21 million Black Americans and $619 billion for all minority plan participants. 

The Advancing Auto Portability Act of 2022 would encourage the widespread adoption of auto portability by creating a $500 tax credit to assist businesses with auto portability implementation costs. It also would make 2019 guidance from the U.S. Department of Labor (issued specifically to Retirement Clearinghouse) permanent and applicable to any auto portability provider. 

Read more: Targeting small, uncashed 401(k) distribution checks can generate big savings

The legislation, and auto portability itself, have received bipartisan, mainstream support both in and out of Congress. Derrick Johnson, president and CEO of the National Association for the Advancement of Colored People (NAACP), wrote in his letter of support for auto portability: "Although auto portability alone will not address the racial wealth gap, it has the ability to positively support the ability of Black workers to build lucrative retirement investments by creating a streamlined approach to savings; one that reduces the opportunities of workers to withdraw investments."

Other leaders, including Marc H. Morial, president and CEO of the National Urban League, have identified and spoken out on the value auto portability can have when it comes to reducing the wealth gap. Additionally, a 2017 letter from Senator Scott to the Department of Labor on the matter received backing from the U.S. Chamber of Commerce, as well as trade organizations including the American Benefits Council, Investment Company Institute, Financial Services Roundtable and Women's Institute for a Secure Retirement. 

This broad bipartisan support behind auto portability has been crucial for getting us to this point. If the legislation is signed into law, the retirement-savings gaps in our society can begin to be filled.