You don’t need me to remind you that 2020 has been an extraordinary year that many of us would like to forget. The New Year we have been looking forward to for some time is now here.
While we all hope for an end to the pandemic, and a return to economic and social normalcy, in 2021, interest rates are likely to stay at their near-zero levels for the foreseeable future. And with interest rates continuing to hover at historic lows, every dollar will count for retirement-savers going into 2021.
Defined contribution plan sponsors can play an important part in helping their participants save more for retirement — and the measures for doing so can also improve their plan structures and metrics.
New Year’s resolution #1 for sponsors: Launch a robust search program for missing participants
In March 2018, Boston Research Technologies Founder and CEO Warren Cormier’s groundbreaking study, “The Mobile Workforce’s Missing Participant Problem,” reported that missing participants are a huge problem for 401(k) plan sponsors and recordkeepers. The study found that changes in jobs by participants create a stale address record for one-fifth (or 20%) of 401(k) accounts. The reason? The participants with out-of-date addresses never informed the recordkeepers of their former-employer retirement plans they had moved.
Meanwhile, the study also reported that 11% of account records for terminated participants have an outdated address, and most of these accounts, particularly those with less than $10,000, belong to Millennials.
If 401(k) plan sponsors haven’t done so in the more than two years since the publication of Mr. Cormier’s study, they should implement a robust search program to locate missing participants.
Sponsors can work with their recordkeepers, or retain a third-party search provider, to set up a thorough program for tracking down missing participants. For those sponsors that do have procedures in place for finding missing participants, December is the ideal time of year to check if their programs need an upgrade.
At the very least, as per their responsibility as fiduciaries, plan sponsors should be able to contact missing participants to remind them about their stranded accounts, and encourage them to begin the process of rolling their balances into active accounts in their current-employer 401(k) plans.
According to our industry research, leaving behind just one 401(k) account in a former employer’s plan can significantly deplete a participant’s retirement savings. If a hypothetical 30-year-old participant leaves behind a 401(k) account with $5,000 after changing jobs today, they would pay $2,052 in fees on that account by age 65. On a compounded basis, assuming the account grows by 7% per annum, this translates to a total loss of $8,488 in retirement savings.
Tracking down missing participants and alerting them about stranded accounts can also prevent those small balances (with less than $5,000) from being automatically rolled out of plans and into safe-harbor IRAs. These automatic rollovers of small accounts are permitted under the Economic Growth and Tax Relief Reconciliation Act of 2001. But the default investment vehicles in safe-harbor IRAs can only invest in money market funds and other principal-protected products, which have yielded low returns in recent years as a result of the historically low interest rates we discussed above.
Many safe-harbor IRAs have only generated between 0.1% and 0.5% in annual interest in recent years — and these amounts are lower than the fees they charge accountholders. According to publicly available product information, some safe-harbor IRAs charge $50 or more in administration fees every year — much higher than twice the interest earned on the average $1,600 account balance with a 1% yield.
The benefit of a robust program to search for missing participants is that sponsors may be able to prevent automatic rollovers into safe-harbor IRAs, and encourage terminated participants to “rescue” stranded accounts that can deplete savings.
New Year’s resolution #2 for sponsors: Amend plans to avoid automatic cash-outs
Besides small, stranded accounts with less than $5,000, sponsors are also permitted to remove terminated-participant accounts with under $1,000 from their plans.
However, instead of doing so in a way that at least keeps the assets incubated in the U.S. retirement system, small accounts with balances below $1,000 are most often unilaterally removed from plans through automatic cash-outs.
If a terminated-account balance of under $1,000 is automatically cashed out, and the sponsor’s recordkeeper mails the check to an address that is out of date, the accountholder likely won’t receive the check. This can open sponsors up to significant fiduciary liability down the line.
Adopt one solution for accomplishing both New Year’s resolutions
Fortunately for sponsors, auto portability — 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 — has been live for more than three years.
Auto portability is powered by “locate” technology and a “match” algorithm which work together to identify participants who are likely missing, track them down, and begin the process of rolling their stranded accounts into active accounts in their current-employer plans. However, even more importantly, auto portability can also enable participants to transport and consolidate their 401(k) savings at the point when they change jobs.
Approximately 40% of job-changing participants choose to prematurely cash out their 401(k) savings within one year of their start date at a new employer, according to the Employee Benefit Research Institute (EBRI) — which also found that the U.S. retirement system loses $92 billion in assets every year, largely as a result of cash-outs.
Prematurely cashing out 401(k) savings is one of the most destructive decisions a participant can make. The Center for Retirement Research at Boston College reports that 401(k) cash-outs can decrease a participant’s total retirement savings by 25%, on average.
Making matters worse is that our country’s most economically vulnerable, including minorities, low-income workers, and the young, are the most prone to cashing out. According to industry data, 63% of Black workers, and 57% of Hispanic participants, cash out within a year of changing jobs—as well as 50% of workers earning $20,000 to $30,000 in annual income, and 44% of participants between ages 20 and 29.
However, EBRI estimates that, if auto portability were broadly adopted by sponsors and recordkeepers nationwide, up to $1.5 trillion in savings, measured in today’s dollars, would be preserved in the retirement system over a 40-year period — simply by plugging cash-out leakage from small balances. That $1.5 trillion in savings would include about $191 billion for 21 million Black Americans, and $619 billion for all minority workers.
Auto portability has also been proven to improve a key plan metric — average account balance. Just four months after implementing auto portability, a large plan sponsor in the healthcare services industry was able to increase the average account balance of participants who leveraged auto portability by 48%, according to a 2017 case study by Boston Research Group.
Auto portability, which is already live and in the process of being adopted across the country, can revolutionize sponsors’ programs for tracking down missing participants, and eliminate the need for automatic cash-outs (as well as automatic rollovers into safe-harbor IRAs). Simultaneously, this solution can help sponsors strengthen their average account balances and other important metrics, while potentially reducing fees.
Talk about starting the New Year off with a bang!
