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 the opportunity to shine some light on safe harbor IRA practices. We hope you’ll find the audio enjoyable and informative.

NARRATOR: For 401(k) plan sponsors, clear fee disclosures are essential for fulfilling their duty to act in the best interest of participants. This transparency is particularly crucial for safe harbor IRAs, where many small-balance 401(k) savers are routinely placed upon leaving their jobs. Without the protection of ERISA, these accounts can often lead to sub-optimal participant outcomes, if the plan sponsor doesn't exercise their due diligence.

Safe harbor IRAs were established to address the challenge of small 401(k) account balances, resulting from the growth of 401(k) plans and the mobile workforce they serve. The intention was for automatic rollovers into these safe harbor IRAs to preserve former participants' savings, until such point as they could be moved or consolidated into a more appropriate retirement savings account. The fact is, that while safe harbor IRAs have helped plan sponsors manage costs and risks, they've largely failed participants. Cash-out rates remain very high, and nearly all remaining balances earn minimal returns, often never moving beyond their default money market investments.

Research from October 2020 by EBRI identified safe harbor IRAs as the primary cause of an explosion in small-balance IRAs, with an estimated 8.1 million accounts likely being safe harbor IRAs. Unfortunately, some providers may be exploiting this large pool of small balances to generate substantial profits, often by charging excessive fees to former participants, offering overpriced and suboptimal investments, and creating barriers to exiting the accounts.

While these practices are not illegal, the sheer volume and nature of the fees can be concerning. Examples of fees found include initial setup fees of up to 20% of the initial balance, high annual maintenance fees, account closure fees, search fees for missing participants, paper statement fees, escheatment fees, and various other transaction fees.

The financial impact on former participants can be severe. In one hypothetical example, a 25-year-old with a $1,200 401(k) balance could lose almost $400 to fees within just two years in a safe harbor IRA, retaining only $801. This contrasts sharply with cashing out, which might yield around $550 after taxes and penalties, or rolling over into a new plan, which could see the $1,200 grow to approximately $12,000 by retirement.

Furthermore, accessing remaining funds can be difficult and costly, with some providers requiring a medallion signature guarantee that can cost around fifty dollars. If a distribution is obtained, individuals often have to manage the rollover process into a new plan independently. For those who leave their savings unattended, layered fees can relentlessly deplete balances until they reach zero, typically through a final account closing or escheatment fee.

Plan sponsors with automatic rollover provisions have a fiduciary duty to act in the best interest of their participants. This includes thoroughly understanding all relevant service fees, third-party agreements, and other factors that could significantly impact participants’ retirement benefits. Unfortunately, many plan sponsors simply adopt the default automatic rollover solutions from their primary provider, often performing only superficial due diligence.

To ensure transparency regarding safe harbor IRA fees, plan sponsors should ask their service providers for the following five items: 1) a complete written list of all participant fees; 2) a close examination of default investment fees, including their structure, who benefits from them, and any lock-up provisions or liquidity issues; 3) written details of all third-party fee-sharing arrangements; 4) identification of any barriers to exiting the safe harbor IRA, such as signature guarantees and 5) information on the level of assistance provided for consolidating funds, including rollovers; and historical metrics, with supporting data, on cashout leakage, median account duration, and the number of assisted consolidations.

By asking these questions, 401(k) plan sponsors can help ensure their former participants are not burdened by excessive safe harbor IRA fees, overpriced investments, or obstacles to accessing their savings. This due diligence not only improves participants' retirement prospects but also helps sponsors properly fulfill their fiduciary duties, ensuring that safe harbor IRAs genuinely serve their intended purpose.

For a comprehensive checklist that plan sponsors can utilize to evaluate their automatic rollover IRA provider, just click on the link in the show's transcript.

Links:
Comprehensive Criteria for Selecting an Automatic Rollover IRA Service Provider

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