Could this simple proposal help boost retirement savings?
While it didn’t make headlines at the time, a letter from 11 Republican U.S. senators last summer could impact the retirement plans of millions for the better.
In the July 2017 letter to Labor Secretary Alexander Acosta, the senators asked the department for guidance on auto portability, writing that without the Department of Labor’s advisory opinion, “plan sponsors and others lack clarity around what can be done under the law to facilitate auto portability.”
As of early December, the department had not made any headway in issuing a statement or other activity.
Still, experts believe the DOL will issue its opinion sometime in the near future. But what exactly is this concept, and why could it amount to a retirement game changer?
Auto portability is the routine, standardized, and automatic movement of an inactive participant’s small-balance retirement account — less than $5,000 — from a former employer’s retirement plan to an active account in a new employer’s retirement plan. If a worker switches employers, auto portability would guarantee that whatever sum remains in the old retirement account will make it into the 401(k) or similar account at his or her new job.
That threshold of $5,000 and below might sound like a small amount, and indeed, many workers decide instead to cash it out as an early withdrawal before they change jobs. The cash in hand is easy to treat as a windfall, even with the associated penalties and taxes, but in reality, this phenomenon — known as “leakage” — costs workers dearly in terms of the missed accumulation of retirement income.
Nor is leakage a one-time phenomenon for some workers. Citing statistics from the Employee Benefit Research Institute, Retirement Clearinghouse LLC (RCH), a specialist in portability services for plan sponsors, reports that the average 401(k) participant will hold roughly nine jobs over his or her working career. Annually, that amounts to an estimated 14.8 million workers with retirement accounts changing jobs.
In a May 2017 policy forum, the EBRI shared some eye-opening statistics that reveal the impact of auto portability. Across all income levels, auto portability of balances up to the $5,000 threshold for laborers in the 25–34 age group would result in aggregate balance increases at age 65 of between 21% and 24%.
Currently, “The former employer has rational reasons to force out the employee [from a retirement plan] due to liability and expenses,” said Aaron Schumm, founder and CEO of Vestwell, a digital retirement plan platform. “But it may leave the former employee’s assets in purgatory for some time, where he or she is still potentially paying hefty fees.”
That “purgatory,” for participants with less than $5,000 who fail to take action with their money, is their funds being moved into a Safe Harbor IRA, where by statute they are invested in money market funds that yield little or no interest. And that’s where the fees come in, as administrative charges levied to the former employee’s account can deplete or even exhaust the funds over time.
To that end, a quick, easy rollover into a cost-effective new plan can be highly beneficial to the employee, Schumm said. But for too many, the failure to roll over boils down to one huge hurdle/headache: paperwork.
J. Keith Baker, CPA, a faculty member at North Lake College, in Irving, Texas, points to a 2016 auto portability research study by the Labor Department’s ERISA Advisory Council.
The report has a telling subtitle: “If we take the friction out, more people will stay in.” To roll from one employer’s plan into another, it took 38% of workers from four weeks to two months; another 27% said it took more than two months.
“The report concluded that even if companies and a third-party administrator made the process less complex, transferring a retirement plan into a succeeding plan when an employee changes jobs presents enough obstacles that employees often elect to cash out instead,” Baker said. “So much for making it simpler.”
Testimony from RCH informed the advisory council’s report; RCH findings show that 37% of job changers who cashed out of their retirement accounts did so because they needed the money, while the remaining 63% found it the easiest path available.
“We are cautiously optimistic regarding the senators’ request” for guidance, said J. Spencer Williams, founder, president, and CEO of RCH. The DOL’s advisory opinion will in essence serve as a compass for making auto portability a reality.
With that opinion, the RCH — which conceived and developed the auto portability concept — will work toward creating an auto portability process. Once auto portability begins, the clearinghouse will collect, standardize, and redistribute account information to all record keepers that participate in the program.
According to Williams, the framework for auto portability would be based on current IRS guidelines on what’s called prohibited transaction exemptions (PTEs) that govern activity between retirement plans and people disqualified from them.
Eventually, an IRS exemption will be written that specifically covers auto portability, Williams predicted. But that won’t be needed immediately to make auto portability a reality. The combination of a DOL advisory opinion and current PTE guidelines will be enough to put auto portability into action while the government works out final details, he said.
This means that retirement funds left behind with former employers will finally begin to transfer to the employee’s plan at a new job — and create what Williams called a “hybrid approach” that combines current PTEs with whatever advisory opinion the DOL issues.
“The hybrid approach will be a home run, producing 100% of the well-articulated benefits of auto portability,” he said.
Until the DOL acts, Williams recommends that plan sponsors take three key actions:
Meanwhile, the anticipation for DOL guidance regarding auto portability continues to grow, and with good reason. Plan sponsors will win as well, since small-balance accounts represent an administrative burden because of high levels of missing participants and the accumulation of uncashed distribution checks.
“The employee can participate [in a friction-free rollover], the old employer does not have to pay fees on that investment, and the new employer fees may be reduced as plan assets increase,” said John Blake, CPA, a partner with New Jersey-based accounting firm Klatzkin & Company. “Everyone wins.”
Lou Carlozo is a freelance writer based in Chicago. To comment on this article or to suggest an idea for another article, contact Chris Baysden, senior manager of newsletters at the Association of International Certified Professional Accountants.
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