Recent Pew Charitable Trust research[i] confirmed that high IRA fees had the potential to cost investors “45.5 billion—just from [a] single year of rollovers.” Pew also confirmed that “rolling retirement assets into an IRA can result in far higher costs to the individual retail investor than their institutional 401k participant counterpart.”
It’s surprising that this is news. Consider the following excerpt from an 11-year-old SHRM article[ii]:
“… Since 2005, defined contribution retirement plan sponsors have had the option to automatically roll over the plan assets of departing employees into individual retirement accounts if those accounts are worth [up to] $5,000. Before this change, plan sponsors used to pay lump sums for balances less than $5,000 …
Of course, some plan sponsors specifically choose not to allow automatic rollovers …this approach is driven by the realization—particularly among sponsors of larger plans—that the remaining assets in the 401k plan will be invested in institutionally priced funds while most IRA assets will be invested in retail funds. These plan sponsors recognize that a rollover often involves moving assets from an employer’s plan with very low-fee institutional funds to an account with higher-cost retail investments. This can make retirement investing more expensive for departing employees than if they had been able to leave their money in the former employer’s plan.”
Magnet features
In my last plan sponsor role, we strategically changed various provisions to morph our 401k into an “asset magnet”—one of many that converted our plan into a “Lifetime Financial Wellness Instrument”.[iii] Some were prompted by changes to the taxation of lump-sum distributions and required minimum distributions that were a part of the Tax Reform Act of 1986. Before 1989, we limited post-separation payouts to lump sums coupled with processes that prompted distribution for every participant who separated before age 55.
Over the ensuing decades, we made radical changes to our plan’s distribution provisions. Today, that plan allows ad-hoc and installment payments. Other “asset magnet” features of specific value to active and term vested/retired participants included:
- Elimination of in-service hardship withdrawals,
- Electronic banking for both distributions and plan loans,
- 21st Century loan functionality, which allows workers to not only continue loan repayments after separation but to initiate a loan post-separation, and
- “Rollover into” flexibility, at hire, while employed, and post-separation – including features that facilitate the “rollover” of defaulted loans from a predecessor or subsequent employer’s plan.[iv]
Today, in that plan, over $1.5 billion in assets belonging to over 20% of the participants are folks like me—people who no longer work there. And that employer-sponsored plan is just one of many with strategies that favor asset retention[v]. 2019 Department of Labor Form 5500 data show that approximately one in five of the more than 98 million accounts in single-employer defined contribution plans belong to a term vested or retired individual![vi]
Yet another ripoff
Retail asset management fees are only the first part of “Rollover Ripoff.” Consider this study by the Employee Benefits Research Institute (EBRI) based on an examination of their IRA database of over 11 million accounts:[vii]
“… One extreme [investment] allocation … can be attributed to a safe harbor regulation. In 2005, the Department of Labor (DOL) issued regulations that—with respect to automatic force-outs of employment-based retirement plans with values of $1,000 up to $5,000 to IRAs … so long as the designated IRA provider of the automatic IRA … limits the initial investment choice of the IRA to those products designed to preserve principal and provide a reasonable rate of return. The result has been that a significant percentage of small IRAs are found to be invested 100 percent in money in Rollover IRAs.
This is true even though many had 100 percent allocations to balanced or target-date funds In their 401(k) plan. Diversified asset allocation funds are, of course, the safe harbor default for automatic enrollment arrangements in defined contribution plans. EBRI’s analysis finds that the safe harbor default affects many investors for long periods of time … over one-fifth (22.7 percent) of Traditional Rollover IRAs had balances of less than $5,000 … 55.6 percent of the owners of Traditional Rollover IRAs with balances of $1,000 up to $5,000 were ages 44 or younger, and 27.2 percent of these accounts were at least seven years old … three-fourths or more of accounts of those ages 25 to 29 that were established 7–11 years prior to the analysis year were 100 percent allocated to money. More than 85 percent of those established in the same year as the analysis year were fully invested in money …
In the current interest rate environment, resulting returns … may not even outpace the reasonable fees that cover the administration of the accounts …”
Starting July 1, 2022, Prohibited Transaction Exemption 2020-02 now requires advisors to provide a written explanation of the specific reasons why the rollover from a retirement savings plan to this specific IRA “is in that individual investor’s best interest right now.” [viii]
“The relevant factors include but are not limited to: [ix]
- The alternatives to a rollover, including leaving the money in the investor’s employer’s plan, if permitted;
- The fees and expenses associated with both the plan and the IRA;
- Whether the employer pays for some or all of the plan’s administrative expenses; and
- The different levels of services and investments available under the plan and the IRA.”
Hopefully, going forward, we can avoid the travesty of IRAs, owned by individuals under age 44, that are invested in money market funds for more than seven years.
I always appreciate your comments, concerns, criticisms, or questions. Contact me at: jacktowarnicky@gmail.com.
Disclaimers and references
Disclaimer No. 1: My comments are my own based on my past experiences in plan sponsor roles and do not necessarily reflect those of any employer or association I have been employed by or affiliated with, past, present, or future.
Disclaimer No. 2: Information was provided by individuals with knowledge and experience in the industry and not as legal or tax advice. The issues presented here may have legal implications and you should discuss this matter with legal counsel prior to choosing a course of action. This article is intended to be informational only. It is not (and you/others should not use it as a substitute for legal, accounting, actuarial, or other professional advice. Any advice contained in this article was not intended or written to be used and cannot be used by anyone for the purpose of avoiding any Internal Revenue Code penalties that may be imposed on such person [or to promote, market or recommend any transaction or subject addressed herein]. You (others) should seek advice based on your (their) particular circumstances from an independent tax advisor.
[i] J. Sullivan, Rollover Ripoff: IRA Investors Pay ‘Significantly’ More Than 401k Participants, 7/1/22, Accessed 7/3/22 at: https://401kspecialistmag.com/rollover-rout-ira-investors-pay-significantly-more-than-401k-savers/?utm_source=email&utm_medium=link&utm_id=1546965750&utm_term=Rollovers&utm_content=606c94c642bb0397bd8b45e4 [ii] J. Sammer, Moving Assets: Automatic 401(K) Rollovers: Save administrative time and reduce plan costs by moving small balances out of defined contribution plans. 3/1/11, Accessed 7/3/22 at: https://www.shrm.org/hr-today/news/hr-magazine/pages/0311sammer.aspx [iii] J. Towarnicky, My Financial Wellness Solution: The 401(k) as a Lifetime Financial Instrument, 2017, Accessed 7/3/22 at: https://www.soa.org/globalassets/assets/files/resources/essays-monographs/financial-wellness/2017-financial-wellness-essay-towarnicky.pdf [iv] J. Towarnicky, Stop Leaks: Plan Loans, 401kSpecialist.com, 11/29/20, Accessed 7/3/22 at: https://401kspecialistmag.com/how-to-stop-401k-leakage-from-plan-loans/[v] J. Towarnicky, RBD/RMD for You; RBD/RMD for Me, 1/12/20, Accessed 7/3/22 at: https://www.psca.org/news/blog/rbdrmd-you-rbdrmd-me
[vi] Employee Benefits Security Administration, US Department of Labor, Private Pension Plan Bulletin Historical Tables and Graphs, 1975-2019, Accessed 7/3/22 at: https://www.dol.gov/sites/dolgov/files/ebsa/researchers/statistics/retirement-bulletins/private-pension-plan-bulletin-historical-tables-and-graphs.pdf [vii] EBRI, Losing Ground Safely: Small IRAs’ Large Stake in Money, 10/1/20, Accessed 7/3/22 at: https://www.ebri.org/docs/default-source/fast-facts/ff.364.ira2017.1oct20.pdf?sfvrsn=637a3a2f_8 [viii] J. Sullivan, Advisors Unprepared for New 401k Rollover Rules: A Rollover recommendation has to be disclosed as a conflict of interest,’ says ERISA expert Fred Reish, 401kSpecialist.com, 6/28/22, Accessed 7/5/22 at: https://401kspecialistmag.com/advisors-unprepared-for-new-401k-rollover-rules/ [ix] Employee Benefits Security Administration, U.S. Department of Labor, New Fiduciary Advice Exemption: PTE 2020-02, Improving Investment Advice for Workers and Retirees Frequently Asked Questions, April 2021, Accessed 7/5/22 at: https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/faqs/new-fiduciary-advice-exemption
Jack Towarnicky provides independent benefits consulting and serves as a member of aequum, LLC and of counsel for Koehler Fitzgerald, LLC.
