The risk of inactive retirement plan participants

A recent revenue ruling from the Treasury Department and the IRS eases the administrative burden for 401(k) plan sponsors wanting to accept rollovers from other employers’ plans, but the fiduciary risk posed by inactive accounts still remains.

 In an effort to make workplace retirement savings more portable and to help build assets in tax-qualified retirement plans, the Treasury Department and Internal Revenue Service have removed a cumbersome step plan sponsors must take when accepting rollovers from other employers’ plans.

IRS Revenue Ruling 2014-09, released in April, allows the plan administrator for the receiving plan to now simply check a recent annual report (Form 5500) filing for the sending plan on a public database.  This eliminates the need for the two plans to communicate (with the individual as go-between), expedites the rollover process, and reduces associated paperwork, says the IRS.

Also see: Greasing the skids on 401(k) rollovers

“What a plan sponsor had to do before was take on the responsibility and the risk that the employee’s rollover actually came from a clean and compliant 401(k) plan,” says Marina Edwards, senior consultant, benefits advisory and compliance with Towers Watson in Chicago. “If they had accepted rollover money from a plan that had compliance defects – even a little teeny $1,500 rollover – it had the potential to disqualify the compliance of the receiving plan.”

The new ruling, she says, is “one small step that helps alleviate that potential fiduciary risk.”

“All too often, individuals moving from one job to another find it too difficult to take their retirement plan savings with them to a new employer,” says J. Mark Iwry, senior adviser to the Treasury Secretary and deputy assistant secretary for retirement and health policy.  “This guidance is designed to make it easier for people to roll over their retirement savings to a new employer plan when they change jobs, helping them preserve and accumulate assets for retirement.”

And while the new ruling will help alleviate fiduciary risk associated with accepting rollovers, it does nothing to mitigate the potential risk posed to workplace retirement plans with inactive accounts – those accounts left in the 401(k) plan when an employee moves on to another job.

“There are barriers to folks consolidating in their employer plan and the Revenue Ruling served to lower one of those,” says Spencer Williams, CEO of Retirement Clearinghouse, a company that offers a retirement plan consolidation service. He notes there are still several barriers for plan participants who want to roll over assets from a former plan into their new employer’s plan.

“Portability is very difficult for the average participant to achieve on their own,” he says. “It’s a terribly unfamiliar process and it’s very time-consuming to do it by yourself.”

As a result, many plan participants with small balances are more likely to cash out their 401(k) accounts than leave them in the plan or roll them over to the new employer’s plan. The defined contribution system is efficient at bring assets into plan accounts, but weak at moving money between accounts, believes Warren Cormier, president of Boston Research group and a leading market researcher in the DC industry.

“The result is too often leakage – participants taking the paths of least resistance by cashing out or leaving their accounts behind with their old employers, which result in huge costs to them, employers and providers,” he says. “The goal is obviously to stop cashouts and keep the dollars either in their next employer’s DC plan, preferably, or in a qualified account such as a low-cost [individual retirement account].”

Talk to any financial adviser and they’ll invariably tell you that one of the key benefits of working with them is that they will consolidate all of your investment accounts, which makes for easier recordkeeping and potentially lower fees and the same can be said for 401(k) accounts.

“If you’re needing an income which, certainly most people are going to need from these accounts, it’s much easier to plan your distribution if it’s all together in one place, rather than spread around in various spots,” says Ted Benna, a retirement plan consultant.

A Boston Research Group study of a plan sponsor in the health care industry – with 200,000 participants and a 25% annual turnover rate – found that using a consolidation service, including providing employees with personalized start-to-finish advice, cut cashouts in half, reduced the number of stranded accounts and saved an estimated $6 million in costs.

“Many plan sponsors aren’t even aware of the magnitude of the cashed-out problem with their ex-participants,” says Cormier. Moreover, “they’re not particularly focused on the fiduciary risk that they may face [from inactive accounts.]”

There’s a fairly significant list of information plan sponsors are required to provide 401(k) plan participants, whether they’re active employees or have moved on – summary plan descriptions, material modification notices when there are changes to the plan, annual statements, fee disclosure information, to name a few.

“Employers are obligated to treat former employees who leave their account balances in their 401(k) plans just as they would any other plan participant,” says Robert C. Lawton, president of Lawton Retirement Plan Consultants, LLC.. “In other words, the employer cannot discriminate against former employees with balances by taking away their website privileges, for example, or refusing to send them quarterly participant statements, unless everyone else in the plan is subject to the same conditions.”

Moving to a new provider, or adding or removing an investment fund from the 401(k) plan line-up, for example, necessitate additional communications and,  in the case of moving to a new provider, employees may need a little extra help. And it’s a lot harder for benefits professionals to provide the same level of support to former employees as they do to active plan participants.

“If there are many former employees who you haven’t been able to reach and then you can’t provide all the communications that you’re giving out to active participants, that clearly leaves you with exposure,” says Benna, adding that benefits professionals are extremely busy. “When they show up in the morning, they have more [to do] than what they’re ever going to get done in a day so their attention is predominantly going to be focused on active employees,” he says.

Cormier agrees. “Being an active employee puts you in a better position to be getting updates and makes it easier for the plan sponsor to be meeting their fiduciary responsibilities,” he says.

There are generally four options available to workers with 401(k) balances when they leave their employer: leave it in the former employer’s plan, cash it out, roll the balance over into the new employer’s plan, or roll it into an individual retirement account.

But there are sometimes good reasons for leaving money in a former employer’s plan, even if it causes headaches for the plan sponsor, says Lawton. “For example, a participant who rolls money into an IRA will probably have to pay for investment advice, which is often provided free of charge or at heavily discounted rates to 401(k) plan participants,” he says. In addition, the new employer may not offer a 401(k) plan.

Retirement Clearinghouse’s consolidation service – which it bills as a concierge, case management service – costs a flat rate of $79, regardless of the participant’s balance. It’s a cost plan sponsors can pay for, too, and Williams says all of his plan sponsor clients promote the service as an employee benefit, even if they choose not to pick up the tab. “Our largest client pays for it as a permissible expense of the plan, so the plan is picking up the expense,” he says.

Since launching the service three years ago, Williams says between 8,000 and 10,000 people have used the consolidation service. There’s an additional $49 flat rate to consolidate a second account and there’s no charge for the third and subsequent accounts.

For plan sponsors, one of the benefits of having new employees use the service is that Retirement Clearinghouse “will do all of the chain of custody work to make sure the money [coming in to the plan] is qualified,” says Williams.