Michael Kreps is Principal and Co-Chair of the Retirement Services Practice at Groom Law Group. Previously he served as the Senior Pensions and Employment Counsel for the U.S. Senate Committee on Health, Education, Labor, and Pensions.
Every year, millions of Americans leave behind small 401(k) accounts when they change jobs, and employers are permitted to force payment of those assets to the job leavers, out of their plans. The practical result is that too many people cash out their savings, draining billions of dollars from the retirement system every year. These cash-outs are due, in no small part, to the fact that the US retirement system makes it too difficult and time consuming for people to move their accumulated savings to their new employers. Fortunately, there is growing momentum to address this problem by implementing “auto portability.”
Employers can force out small 401(k) accounts because these can be costly to administer, and the administrative expenses of keeping them can even exceed the value of the accounts. Congress sought to help with this problem by allowing firms to involuntarily distribute accounts valued under $5,000 of former employees. This approach significantly reduced the number of small accounts, but it created a whole new problem: cash-outs.
While people can take these distributions and move them to another 401(k) or an IRA, many just cash out because it can be too difficult and complicated to roll over their savings. Research indicates that at least one third, and sometimes close to half, of plan participants withdraw part or all of their retirement plan assets following a job change. The lost savings due to these cash-outs amounts to $60-$105 billion each year.
Cashing out is one of the most detrimental choices a person can make when it comes to retirement readiness. Not only must people pay a tax penalty for the cash-out; many are left without any retirement savings. For instance, a 30-year-old worker who cashed out a $5,000 401(k) savings account today could give up about a $30,000 balance that would have accrued by age 65.
To address the problem of cash-outs, auto portability can be the solution. The idea behind auto portability is to permit small accounts to automatically follow workers leaving one employer plan by rolling the money to another plan, instead of forcing the payment. While some may still cash out their savings, the millions who take advantage of this default will retain money in the retirement system and enjoy a more secure retirement.
Auto portability is likely to have an enormous impact on the US retirement system. The Employee Benefit Research Institute estimated that auto portability could preserve an estimated $1.5 trillion in additional retirement savings over a generation. The projected impact is even greater when auto portability is coupled with federal and state proposals to expand retirement plan coverage.
Putting auto portability in place is no small task, as it will require building a network of 401(k) service providers and establishing a clearinghouse to move accounts from point A to point B. Additionally, the system is subject to regulatory guardrails established and overseen by the U.S. Department of Labor. Nevertheless, there has been major progress recently, and two of the largest 401(k) recordkeepers – Alight and Vanguard – recently announced the implementation of auto portability.
It is hard to overstate the potential of auto portability to transform the US retirement system. It will undoubtedly preserve many small accounts, making retirement more secure for millions of people. It also provides the infrastructure necessary to make all 401(k) accounts truly portable and to solve vexing problems like locating “missing” participants.
Views of our Guest Bloggers are theirs alone, and not of the Pension Research Council, the Wharton School, or the University of Pennsylvania.
