For years, 401(k) plan sponsors and record-keepers have received research findings discussing the harm caused by participants cashing out or stranding their small accounts. This is a big problem for the U.S. retirement system as a whole, and given the lack of an industry-wide framework to address the issues, there hasn’t been much that sponsors and their record-keepers could do about it.
The mobility of today’s workforce is greater than at any other period in our nation’s history. According to the Employee Benefit Research Institute (EBRI), the average American will change jobs at least 7.4 times during a 40-year working career. The highly mobile nature of the modern workforce, combined with the widespread adoption of auto enrollment, has led to a surge in small and/or stranded 401(k) savings accounts. Confirming this trend, the Bipartisan Policy Center clearly identified the connection between small accounts, cash-out leakage and the need for improved portability solutions earlier this month in a report titled Securing Our Financial Future: Report of the Commission on Retirement Security and Personal Savings.
Now, thanks to the Auto Portability Simulation (APS), record-keepers will be able to quickly visualize how they, their plan sponsor clients and their participants will benefit from the adoption of technology and processes that make it easy to transfer 401(k) balances between plans at the point of job change, stemming cash-out leakage and retaining savings in qualified plans.
The APS was developed jointly by Retirement Clearinghouse and Dr. Ricki Ingalls of Texas State University, incorporating data provided by Dr. Jack VanDerhei, EBRI Research Director, behavioral finance expert Warren Cormier, CEO of Boston Research Technologies, and Retirement Clearinghouse’s portability solutions database of several hundred thousand participant transactions completed over the past 9 years. By means of the APS’ discrete event simulation, record-keepers can view, for the first time, a scenario in which auto portability (the standardized, routine plan-to-plan transfer of retirement savings accounts with less than $5,000) is widely adopted over a 10-year period and remains in effect for a generation – and compare the outcomes to the current state of retirement plan portability. These results can be readily translated and reported at the industry level, by record-keeper, and at an individual plan level.
Incorporating the book-of-business profiles of the 25 largest 401(k) record-keepers, the APS demonstrates that over the course of a generation, broad adoption of auto portability can reduce cash-outs of small 401(k) accounts from $7 billion per year (the current rate) to less than $2.5 billion annually. In addition, the APS shows that the number of participants who roll their less-than-$5,000 401(k) accounts into their new employers’ plans every year would rise from an estimated 200,000 per year at present to over 3 million people per year, which would ultimately benefit about 76 million participants over the 30-year, forward-looking time frame of the simulation.
The APS tracks, and is able to report, the transaction, account and asset volume of in-flows and outflows at an industry level and for each record-keeper, enabling plans and record-keepers to analyze the impact auto portability will have on their operations and businesses, putting them in control of the pace of adoption. The APS also enables record-keepers and asset managers that offer products like target-date funds to view projected asset flows into their products, as well as the economics associated with those flows.
Furthermore, the APS demonstrates that as a result of plugging cash-out leakage, today’s and tomorrow’s generations of plan participants would accumulate new savings of $115 billion in retained qualified-plan assets. But as the saying goes, that’s only the tip of the iceberg. High-level estimates indicate that only 10% of all cash-out leakage is attributed to 401(k) accounts with less than $5,000. Imagine the substantial impact on participants’ retirement readiness that would result if sponsors and record-keepers were to implement similar portability solutions to facilitate frictionless plan-to-plan transfers, regardless of account balance!
As illustrated by the APS, approximately 5 million Americans with 401(k) account balances of less than $5,000 switch jobs every year, and the absence of an industry-wide framework for seamlessly and automatically moving these small accounts between employer-sponsored plans at the point of job change causes many participants to either cash out, or leave their accounts behind in their former-employer plans. Approximately 89% of annual leakage is caused by cash-outs, according to the U.S. Government Accountability Office, and most cash-outs occur within one year of job change. That leads us to another 89% statistic – the APS shows that over the life of an accounts, an estimated 89% of all 401(k) accounts with less than $5,000 are cashed out, either within the first year of job change (we call this “fast leakage”) or in successive years, after they’ve been automatically rolled over to safe-harbor IRAs or left in plans that don’t utilize a mandatory distribution service (we call this “slow leakage”). Taken together, fast and slow leakage threaten the retirement security of the millions of participants that change jobs each year.
Understanding both types of cash-out leakage is crucial because record-keepers and their plan sponsor clients can utilize the APS to understand the magnitude of the problem, and to also recognize that facilitating auto portability for small accounts today can lead to impressive results tomorrow. The APS ties all of the above previously-disconnected research findings together and clearly illustrates their cumulative effect on the U.S. retirement system, and each record-keeper, in terms of retained participants, retained savings, and auto portability’s economic benefits to their business.
The APS visually demonstrates how auto portability can dramatically reverse today’s tidal wave of premature cash-out leakage over the course of a single generation. It also conjures up an easily-imagined greater good if improved portability solutions are broadly adopted for all segments of America’s mobile workforce.
Spencer Williams and Neal Ringquist are President/CEO and Executive Vice President of Sales and Marketing, respectively, of portability solutions provider Retirement Clearinghouse.
