The long-awaited Department of Labor (DOL) guidance on the legal and regulatory framework for auto portability has cleared the way for plan sponsors to further enhance and optimize their automatic rollover programs. By explicitly recognizing auto portability’s potential benefits to retirement savers, the DOL acknowledges that existing ARO programs have flaws which auto portability can fix.
An ARO, also known as a mandatory distribution, is a forced rollover, to a safe-harbor IRA, of a terminated-participant account with a balance of less than $5,000—undertaken if the participant has failed to respond to notices to move their account balance out of the plan. First created by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTTRA), the ARO has been a common plan design feature since 2005.
In many cases, sponsors have maintained their plans’ ARO infrastructure for years. Some sponsors who have legacy ARO systems in place may not, at first glance, see the need for updating them. However, just like checking under the hood of a trusted automobile and conducting a basic safety check, taking a closer look at the inner workings of ARO programs can shine a light on features that require attention, particularly in light of the recent DOL guidance on auto portability.
Below is a five-point checklist that sponsors, like auto mechanics, can use to assess the health of their ARO program engines.
- Check Fees: The fees charged to plan participants whose accounts are transferred via AROs have decreased dramatically since 2005. Since these accounts tend to stay in safe-harbor IRAs for only about eight or nine months (based on my company’s experience), sponsors need to assess how much the former-participant accountholders are being charged—especially in light of sponsors’ responsibility as fiduciaries.
Ideally, terminated participants should be charged account fees on a monthly basis, not annually, given the short length of time most of these accounts are open. In addition, there should be no “hidden” or add-on fees, such as for qualified domestic relations orders (QDROs), paper statements, missing-participant search fees, investment transfer fees, etc. The fees in many safe-harbor IRAs add up over time and can deplete hard-earned retirement savings.
- Check Safe-Harbor IRA Investment Options: Not all principal-protected investment products are the same. There are still many low-yielding funds in ARO programs, and if terminated participants find out years later that their ARO-transferred accounts have accrued meager returns for long periods, their former employers can be blamed.
Sponsors should ensure that the safe-harbor IRA providers where they transfer small accounts offer high-yielding investment options. At the very least, sponsors need to check that a safe-harbor IRA’s investment options don’t trail money market funds, and don’t include vehicles which lock investors in for an extended time frame or charge a surrender fee, a common feature in insurance contracts.
- Check that Participants are Given a Fighting Chance to Retain Their Savings: The EGTTRA also authorized plan sponsors to automatically cash out small, stranded 401(k) accounts with less than $1,000 in assets. Premature cash-outs are responsible for 89% of asset leakage from the U.S. retirement system, according to the U.S. Government Accountability Office, and diminish participants’ retirement outcomes. If that isn’t bad enough, sponsors who automatically cash out 401(k) accounts and send the checks to out-of-date addresses open themselves up to potential complaints from the accountholders.
Instead of being part of the cash-out problem, sponsors should strive to eliminate automatic cash-outs, and amend their plans so that any ARO provision is applied to all accounts with less than $5,000, as opposed to only accounts with between $1,000 and $5,000.
Another best practice to help participants to retain retirement savings is to offer an ARO program that also facilitates consolidation into an existing IRA or into an active account in a new-employer plan—both during the pre-force-out communication process and after the participant becomes a safe-harbor IRA accountholder.
Finally, no ARO service provider should erect administrative barriers that discourage movement of funds out of the safe-harbor IRA, such as requiring a signature guarantee.
- Check that Your Program Prevents Cash-Outs: You can’t manage what you don’t measure. Ask your ARO service provider if they can provide the number of accounts that have been cashed out from your plan over the past year, and also, if applicable, over the past three to five years.
If your ARO service provider can’t provide a response, then it’s a sign they likely don’t offer terminated participants much assistance, if any, with moving or consolidating their 401(k) savings at the point of job-change. It’s also a sign they don’t provide the necessary communication/guidance to prevent cashing out, in order to encourage participants to keep their retirement savings incubated and invested in the 401(k) system. To mitigate fiduciary liability, and improve plan metrics and participant outcomes, sponsors should work with an ARO service provider that makes an effort to proactively prevent cash-outs.
- Check that the Plan Record-Keeper can Help with Adopting Auto Portability: Upgrading an ARO program to support auto portability—the routine, standardized, and automated movement of a retirement plan participant’s 401(k) savings from their former employer’s plan to an active account in their current employer’s plan—can solve for shortcomings related to the above four checklist items.
Auto portability, which has been live for almost two years, is underpinned by paired “locate” and “match” algorithms designed to locate multiple 401(k) accounts potentially belonging to the same participant, and determine whether or not they actually belong to the same accountholder. If they do, auto portability can facilitate the transfer of their assets through an automated roll-in transaction, either electronically or via a representative, and then go forward with executing and completing the roll-in.
The often costly, confusing, and time-consuming nature of DIY account consolidation is the main reason why participants cash out or strand their 401(k) savings accounts when switching jobs. Auto portability meets the need for seamless plan-to-plan portability which was previously missing from the 401(k) system—and this is why adopting auto portability can help plan sponsors fix problems with their ARO programs.