The pace of change in today’s world is faster than ever -- and accelerating. onsider the vast change witnessed by today’s centenarians over the course of their lives – moving from the horse-and-buggy to aviation, moon landings, the Internet and smartphones.
However, changes to America’s retirement system seem to unfold more slowly – sometimes moving at “the speed of retirement” – a glacial process driven by the moribund pace of legislation, further establishment of rules by regulatory agencies, the delivery of new features by service providers, eventual adoption by the plan sponsor community, and finally – by the individual actions of participants over the course of their working lives.
Even truly transformative change, such as automatic enrollment and default investments such as target-date funds, took years to germinate before legislative action, in the form of the Pension Protection Act, provided the clarity that gave their adoption a needed jump start.
The Small Account Problem: Slow Change Thus Far
Important changes are now making their way to the world of small 401(k) accounts, left behind by separated participants with balances less than $5,000. Like most changes in our retirement system, the initial pace of change was very slow. Those early changes came in the form of automatic rollover provisions that were introduced by EGTRRA in 2001, followed by the DOL’s finalized rules in 2005.
Gradually, plan sponsors began to adopt automatic rollover provisions, and increasingly forced out these small accounts into safe harbor IRAs, helping them manage costs and fiduciary risks. Now, over a decade later, hundreds of thousands of these small-balance accounts had been forced out of their plans and into safe harbor IRAs.
While beneficial to plan sponsors, automatic rollovers typically resulted in poor outcomes for forced-out participants:
- Up to 60% of these participants became retirement savings drop-outs, immediately cashing out their retirement savings, owing taxes and paying penalties.
- Almost as importantly, participants not cashing out were likely exiled to safe harbor IRA “landfills” – where their retirement savings languished, earning money-market returns that were often outpaced by account fees. Meanwhile, cash-outs continued, although at a slower pace.
The “Aha Moment” for Small 401(k) Accounts
April 2013 heralded the arrival of big changes for small 401(k) accounts, when an important “aha moment” occurred. The Boston Research Group’s case study Eliminating Friction and Leaks in America’s Defined Contribution System found that cash-outs could be systematically reduced by 50% - even for small-balance accounts subject to force-out – simply by providing job-changing participants with an enhanced standard of care that included counseling on the high cost of cashing out.
A subsequent, follow-on study in 2015 on America’s Mobile Workforce further demonstrated the value of consolidation to job-changing participants, but particularly to the low-balance demographic segments that are most-often forced-out, including women and Millennials.
Auto Portability Arrives on the Scene
By 2015, the twin goals of reducing cash-outs and promoting consolidation (via electronic records matching) had firmly coalesced to form the pillars of Auto Portability, a systemic solution designed to automatically move a small-balance participant’s 401(k) savings forward to their current-employer’s plan, when they change jobs. Auto Portability, when fully-implemented, promises to completely transform automatic rollovers by incubating small accounts, not throwing them away.
The Auto Portability Simulation (APS) illustrates how this works. A discrete event simulation jointly-developed by Retirement Clearinghouse and Dr. Ricki Ingalls of Texas State University, the APS indicates that, over 30 years Auto Portability will:
- Generate more than $115 billion in savings
- Preserve the retirement savings of over 75 million job-changing participants.
As with automatic enrollment and better default investments, adoption of Auto Portability may need jump start from Washington. Based on recent activity, policymakers in Washington could be ready to deliver what’s needed to drive widespread adoption of Auto Portability.
Other Small Account Changes in the Wind
More changes could be brewing for small accounts. Several influential organizations, including the U.S. Chamber of Commerce and the American Benefits Council have advocated for change in the form of legislative action to increase to the automatic rollover threshold from $5,000 to $10,000, paired with “substantially increasing” corresponding limits for involuntary cash-outs.
Without Auto Portability, this change would benefit plan sponsors, but could have an adverse impact on the retirement outcomes of millions of participants. The Auto Portability Simulation models a scenario where automatic rollover provisions are extended to include all balances less than $10,000, indicating that this balance segment, without the benefit of Auto Portability, would experience cash-outs of almost $490 billion through the year 2045. However, with Auto Portability these cash-outs would be reduced by $218 billion, creating a “win-win” solution.
So what’s next? As predicted before, I firmly believe that 2017 will represent a clear turning point for the delivery of true retirement savings portability, and will be the year that Auto Portability will make significant inroads in our retirement system.Back