In the realm of retirement savings, auto portability is the public policy equivalent of bacon—great by itself, but even better when mixed with other retirement initiatives.
In fact, for many public policy plans to be palatable, auto portability is an essential ingredient.
Our Leaky Defined Contribution System
It begins with cash-out “leakage”—the foulest, frequent and unappetizing outcome emanating from America’s defined contribution system.
Every year, 14.8 million, or 22 percent of all active defined contribution participants change jobs, and consider their options for the retirement savings they’ve left behind.
Six million, or 31 percent, will choose to cash out $68 billion in retirement savings, potentially costing them a timely and secure retirement. The real tragedy is that only one-third of those cashing out need the funds for a financial emergency.
The spoiler that drives cash out leakage is systemic friction. Participants encounter friction when they evaluate their options, finding that cashing out is easy, whereas consolidating their retirement savings is highly difficult.
Put simply, friction makes the best choice—consolidation—the hardest to achieve.
Auto Portability: Great All by Itself
When participants are offered an easy choice to consolidate their retirement savings during job transitions, cash out leakage levels have decreased by over 50 percent.
This is the essence of auto portability—the routine, standardized and automated movement of an inactive participant’s retirement account from a former employer’s retirement plan to their active account in a new employer’s plan. By default, auto portability results in the best choice (consolidation) becoming the easiest choice for former employees.
The efficacy of auto portability in plugging cash out leakage has been validated in several studies, including:
- Auto Portability Simulation
- Eliminating Friction and Leaks in America’s Defined Contribution System
- Portability and the Mobile Work Force
- Making the Right Choice the Easiest Choice
The benefits of auto portability are staggering. The Employee Benefit Research Institute (EBRI) found that auto portability, when applied to account balances below $5,000, would retain $1.5 trillion in retirement savings, in today’s dollars.
Auto Portability Makes Other Public Policy Initiatives Better
While great all by itself, auto portability makes a lot of other retirement savings public policy initiatives better.
- Expanding Access to Defined Contribution Plans
Many retirement savings public policy initiatives share one goal in common—expanding the rolls of defined contribution plan participants. According to The Pew Charitable Trusts, 36.2 percent of American workers do not have access to a defined contribution or defined benefit plan sponsored by their employers.
Initiatives intended to expand access include past legislation, such as the Pension Protection Act of 2006, which enabled automatic enrollment, to a raft of initiatives that are in various stages of consideration today, including:
- Open multiple-employer plans (MEPs)
- Mandate for employers to offer a 401(k) plan
- Mandate for employers to enable auto enrollment and auto escalation
- State-sponsored retirement savings plans
By itself, dramatically expanding access to defined contribution plans is a good thing, and will undoubtedly serve to increase retirement savings.
Unfortunately, dramatically increasing the population of defined contribution participants would also produce a tidal wave of cash outs, since the very demographic segments who benefit most from expanded retirement plan access and coverage are the same segments most likely to cash out. The Auto Portability Simulation model predicts that increasing active DC participants by 36.2 percent boosts annual participant cash outs to 8.2 million, a run rate that could drive 357 million cash outs over a generation – an increase of 96 million over current levels.
Expanding access also creates a dilemma for plan sponsors, who must deal with the administrative hassles and increased costs from an explosion of small balance accounts, along with higher levels of missing participants and uncashed checks.
If auto portability were paired with expanded access programs, the results would be dramatically improved. In fact, the Auto Portability Simulation model predicts that the overall level of cash-outs would decrease from current levels, even when massive increases in participants are factored in. Cashouts would fall from 6 million participants cashing out $68 billion per year, to 4.1 million participants cashing out $46 billion per year.
- Increasing Automatic IRA Rollover Limits
In October 2017, U.S. Congressmen Tim Walberg (MI) and Gregorio Sablan (MP) introduced the Retirement Plan Modernization Act, bipartisan legislation that raises the automatic IRA rollover limits from $5,000 to $7,600. In addition, the bill provides for ongoing, annual increases to these levels.
Similar to initiatives that promote expanded access, H.R. 4158 has merit, particularly for plan sponsors who’ve experienced a surge in small accounts left behind by job-changing participants. In effect, the bill would allow more small balance accounts to be forced-out of plans and into safe harbor IRAs.
Unfortunately, by itself, this legislation would also result in a massive increase in cash outs. Once again, the Auto Portability Simulation model is instructive in modeling H.R. 4158’s outcomes.
As shown in the table below, simply increasing the automatic IRA rollover threshold to $7,600 would produce an increase of 16.9 million small-balance participants who would cash out their retirement savings altogether, over a 30-year period.
Auto Portability Simulation Model Results – Increase to Automatic IRA Rollover Threshold
However, when auto portability is applied to the increased automatic IRA rollover threshold, 88.9 million fewer cash outs result. The net nominal value of the savings that would be preserved is $207 billion, and when these savings are assumed to grow at 6 percent per year, the savings preserved increases to $1.1 trillion.
Auto Portability: A Leading Retirement Savings Public Policy Initiative
Whether it’s considered by itself or paired with other retirement savings public policy initiatives, it’s clear that auto portability is in a league of its own in solving the dilemma of cash out leakage and effectively addressing the small account problem.
While auto portability may also have some characteristics in common with bacon, it’s most-definitely not government “pork” – since auto portability can be delivered by the private sector, at no cost to the American taxpayer.
Let’s hope that auto portability and other worthy initiatives will soon be working together to make a secure and timely retirement a reality for millions of Americans.
Tom Hawkins is vice president of sales and marketing with Retirement Clearinghouse, and oversees all key operational aspects of this area, including RCH’s web presence, digital marketing and plan sponsor proposals. In other roles for RCH, Hawkins has performed product development, helped lead the company’s re-branding, evaluated & organized industry data and makes significant contributions to RCH thought leadership positions.