401ks and IRAs have become the one-two punch helping Americans fight for retirement security.
At the end of last year, the Investment Company Institute (ICI) reported more than $28 trillion had been set aside for retirement, mostly in defined contribution plans and IRAs.
In total, retirement savers have contributed about $7.7 trillion to defined contribution plans, and they’ve tucked away another $9.2 trillion in IRAs.
More than one-third of American households own one type of IRA or another. Most Roth IRA accounts (71 percent) are opened with new contributions.
In contrast, most traditional IRAs (85 percent) are opened with rollovers from defined contribution plans, like 401(k) plans. Some estimates suggest more than one-half of the savings accumulated in 401(k) plans have been rolled over to traditional IRAs.
One of the reasons IRAs hold more retirement savings than 401k plans is because it is far easier for plan participants to rollover savings into an IRA than it is to rollover savings into another 401k plan.
A new paper prepared for the Department of Labor explained:
“Currently, plans are not required to accept incoming rollovers and face no standards for timely and efficient plan-to-plan transfers when people switch jobs. This lack of orderly procedures can make it difficult to move money from an old plan to a new plan. Often, even simple processes for transferring assets between plans require several steps and can take a month or more to complete. Additionally, some plans do not accept rollovers from other 401(k)s.”
Unlike roll-ins to new employers’ plans, rollovers to IRAs are relatively simple and straightforward. In addition, traditional rollover IRAs:
- Preserve the tax-advantages of defined contribution plans and allow savings to continue to grow tax-deferred,
- Provide a broader variety of investment options, and
- May reduce overall account expenses, depending on the IRA chosen and the costs associated with the former employer’s 401(k) plan.
Some of the assets in IRAs come from automatic rollovers. When participants leave accounts behind and become lost or unresponsive, plan sponsors can rollover accounts with balances of $5,000 or less into IRAs, as long as plan provisions allow it.
Once the assets have been rolled over, the former employee is no longer a participant in the plan. The provider of the IRA is not required to search for those missing participants, but some providers conduct these searches as a courtesy to their clients. Typically, automatic rollover IRAs help plan sponsors:
- Streamline plan administration,
- Simplify participant disclosures,
- Reduce plan costs,
- Prevent audits for smaller plans, and
- Reduce potential fiduciary liability.
Automatic rollovers offer a solution to a challenging and, often, expensive problem. According to the GAO, between 2004 through 2013, plan participants left more than 16 million accounts with balances of $5,000 or less in their former employers’ plans.
The aggregate value of the accounts was estimated at $8.5 billion. The median total plan cost for all 401k plans ranges from 0.39 percent to 1.38 percent of assets. Depending on the size of the plan and how costs are split between participants and plan sponsors, the overall cost of accounts left behind may be quite significant
The $5,000 account limit for automatic rollovers was established 20 years ago and was not indexed to inflation. Recently, legislation was introduced to increase the maximum account size for auto rollovers from $5,000 to $7,600, which would have been the limit if these accounts had been indexed to inflation.
If the legislation passes, plan sponsors may need to modify plan provisions to reflect the new maximum.
While evaluating plan documents, plan sponsors may want to consider issues associated with uncashed checks. Today, some plans send checks to former employees with plan account balances of $1,000 or less. When those checks remain uncashed, plan administration becomes far more complicated. An alternative is to have all account balances at or below the automatic rollover limit transferred to Safe Harbor IRAs.
IRAs have become a versatile and crucial retirement tool that helps improve retirement security. Ideally, Americans have access to both qualified retirement plans at work and have access to IRAs when appropriate.
Both help people save for retirement and promote retirement readiness. IRAs, in particular, provide a place to consolidate a lifetime of retirement savings.
Terry Dunne is senior vice president and managing director of Retirement Services at Millennium Trust Company, LLC. Dunne has over 35 years of extensive consulting experience in the financial services industry.
Millennium Trust Company performs the duties of a directed custodian, and as such does not sell investments or provide investment, legal or tax advice.
 Munnell, Dr. Alicia. Belbase, Anek. Sanzenbacher, Dr. Geoffrey. ‘An Analysis of Retirement Models to Improve Portability and Coverage,’ Center for Retirement Research at Boston College and Summit Consulting, February 25, 2018, Page 12. [https://www.dol.gov/asp/evaluation/completed-studies/An-Analysis-of-Retirement-Models-to-Improve-Portability-and-Coverage.pdf]