Although the 401(k) is today the primary retirement-savings vehicle for many hardworking Americans, it can be easy to forget that the 401(k) is still a relatively new phenomenon.In November, we will celebrate an important milestone in the history of the 401(k)—the 40th anniversary of the enactment of the Revenue Act of 1978, which added Section 401(k) to the Internal Revenue Code. Section 401(k) allowed employees to defer compensation without being taxed, and gradually popularized the concept of the employer-sponsored defined contribution plan.
The 401(k) has come a long way since—from a supplement to a pension plan to, now, the primary retirement savings plan—and plan sponsors, record-keepers, service providers, and policy-makers, as well as government agencies, continue to work together to enhance outcomes for participants. For example, the widespread adoption of target-date funds and managed investment products as the qualified default investment alternatives in 401(k) plans has improved retirement outcomes for participants.
The Pension Protection Act of 2006 (PPA) further demonstrated that improvements to benefit participants could be made by leveraging a default structure, requiring participants to “opt out” of beneficial plan features rather than opt in. For example, the PPA allowed plan sponsors to automatically enroll employees in their 401(k) plans, which drove more Americans to participate in the 401(k) plan system.
While auto enrollment increased the number of 401(k) plan participants across the U.S. retirement system, it brought an unintended consequence. Without a complementary plan feature to help participants automatically move and consolidate their savings upon changing jobs, the number of small, stranded accounts has skyrocketed. According to findings from the Employee Benefit Research Institute (EBRI)/Investment Company Institute (ICI) 401(k) database and the Department of Labor’s Private Pension database, active-participant accounts with under $15,000 increased by 34.5% to 31.6 million between 2005 and 2015. This surge in small accounts has led to multiple problems for plan sponsors and participants alike.
The next step in the ongoing modernization of the 401(k) involves adopting plan features which encourage seamless savings portability and consolidation, an innovation called “auto portability.” And just like previous 401(k) improvements like auto enrollment, this innovation doesn’t require complex or costly changes to the retirement system infrastructure. Furthermore, auto portability can be implemented most effectively by employing a default approach where balances automatically move forward as a participant changes jobs (unless a participant opts out of the program).
Auto Portability is Already Here
The American workforce is more mobile than ever before; EBRI has estimated that the average American will hold 7.4 jobs before reaching retirement. In addition, according to quit-rate data from the Bureau of Labor Statistics, the workforce’s monthly turnover rate almost doubled in 10 years, increasing from 1.3% in May 2009 to 2.4% in May 2018. With workers changing jobs more frequently, employers should make it easy for employees to take their 401(k) plan account balances with them when they leave to join a new employer.
Employers are held to a fiduciary standard to act in the best interest of the plan’s participants, but the problem has been that, until recently, there hasn’t been a uniform solution or process for reducing the time, cost, and complexity of rolling 401(k) savings from one plan into another. Rolling an account balance from a former-employer plan and consolidating it into an active account in a participant’s current-employer plan takes a long time from start to finish—and industry research on the mobile workforce has demonstrated that plan participants place a high value on the time it takes to complete the process. According to that research, conducted in 2015 by Boston Research Technologies CEO Warren Cormier, plan participants estimate that, on average, the roll-in process would require them to allocate 19 hours of personal time. That time is valued highly, as Mr. Cormier’s study found that 36% of participants value the personal time they would have to devote to completing a roll-in at between $100 and $500—and 8% reported that they value that time at between $1,000 and $5,000.
Upon coming face to face with the prospect of a cumbersome and expensive roll-in process to consolidate their 401(k) accounts, many participants find doing nothing is the easiest option. Others make the self-destructive decision to prematurely cash out their 401(k) accounts.
Fortunately, a solution for removing frictions in the roll-in process, and helping participants avoid the temptation to cash out or strand their accounts, has already been developed. Auto portability is 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. We designed the auto portability process to work within the U.S. qualified plan system’s existing platforms and data flows, leveraging current mandatory distribution rules for small balances, which have been in effect since 2005. We hope that eventually, auto portability will form the backbone of a nationwide network connecting all defined contribution plans, via their record-keepers, to facilitate low-cost asset transfers between plans as participants move from job to job.
Last year, we at Retirement Clearinghouse completed the first-ever fully automated, end-to-end transfer of retirement savings from a safe harbor IRA into a participant’s active account. We performed this milestone process on behalf of a large plan sponsor in the health services sector—and the technology and process which enabled the transfer underpin auto portability. The service has proven effective for more than a year, helping nearly 1,000 participants to move and consolidate their small-balance IRAs into their current employer’s plan.
According to EBRI, the widespread adoption of auto portability would lead to as much as $1.5 trillion, measured in today’s dollars, being preserved in the U.S. retirement system by plugging rampant cash-out leakage of small balances. The broad implementation of auto portability would increase 401(k) account consolidation too. The Auto Portability Simulation (APS) we developed in conjunction with Dr. Ricki Ingalls of Diamond Head Associates found that, under a scenario where auto portability is widely adopted over 10 years and remains in effect for a generation, the number of participants rolling less-than-$5,000 401(k) savings accounts into current-employer plans would rise from 200,000 per year (at present) to over 3 million annually.
The next significant improvements to the 401(k)—seamless asset transfer and consolidation, and the positive retirement outcomes they generate—are right around the corner. To move the needle, plan sponsors, record-keepers, service providers, policy-makers, and government agencies will have to continue their ongoing collaboration on behalf of the hardworking Americans who rely on the 401(k) to achieve a financially secure retirement.