TRANSCRIPT:

Tom Hawkins: Welcome to another edition of the RCH Consolidation Corner Channel, where we provide you with audio content that explores key issues in the preservation and consolidation of retirement savings. In this episode, we take a hard look at the “risky business” of automatically cashing out separated participant balances less than $1,000. We hope you’ll find the audio enjoyable and informative.

NARRATOR: Each year, about 2.5 million 401(k) participants who change jobs have savings balances under $1,000, making them eligible to be automatically cashed out from their plan. While this might seem like a convenient way to remove small balances from a plan, it can create significant problems for both plans and participants, including numerous uncashed distribution checks and substantial retirement savings leakage. Better alternatives exist that can improve plan efficiency while helping participants preserve their retirement savings.

The genesis for automatic cashouts of small balances arose in the 1990s, when 401(k) plans grew rapidly. With high workforce mobility and limited plan-to-plan portability, small accounts left behind by job-changers multiplied quickly. The Economic Growth and Tax Relief Reconciliation Act of 2001 included provisions that sought to address this problem by allowing 401(k) plan sponsors to automatically cash out terminated participants' balances under $1,000, without their consent.

Though the Department of Labor later established rules for automatically rolling over balances between $1,000 and $5,000 to IRAs, and eventually extended this range to balances under $1,000, many plan sponsors had already adopted the practice of cashing out sub-$1,000 balances. Surveys indicate between 27% and 58% of plan sponsors continue this practice today.

The downside of automatic cashouts is significant. Data from a large plan sponsor shows about 10.5% of sub-$1,000 distribution checks go uncashed and require resolution. These uncashed checks remain plan assets, potentially triggering audits and administrative costs while disconnecting participants from their savings.

For participants, even small cashouts impact retirement security substantially. A 25-year-old whose $750 balance is cashed out could miss out on over $9,300 in retirement savings by age 65, assuming a 6.5% annual return.

A better approach is to include sub-$1,000 balances in automatic rollover programs, transferring them to safe harbor IRAs and reducing uncashed checks. Once IRAs are funded, plan sponsors have fulfilled their fiduciary responsibilities.

However, the optimal solution for both the plan and its participants is to adopt auto portability, which avoids the drawbacks of traditional automatic rollovers such as high fees and continued cashouts. Auto portability automatically transfers balances to a participant's current employer plan, promoting consolidation, reducing cashouts, improving investment options, and helping close long-standing demographic wealth gaps.

For an updated list of recordkeepers who have joined the Portability Services Network, an industry-led consortium dedicated to the widespread adoption of auto portability, visit the link in the show notes.

Links:
Recordkeeping Members of the Portability Services Network (PSN)
RCH Uncashed Distribution Check Service
RCH Automatic Rollover Service

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