Finding missing participants is now a major focus of retirement plan sponsors due to enforcement actions by the Department of Labor (DOL) that some believe are unfair without clear guidance for what plan sponsors can do.
However, a bigger problem for helping participants preserve their retirement savings is cashouts upon termination.
An auto-portability simulation done by Retirement Clearinghouse in 2016 shows that in just more than 30 years, total cashouts could reach $282 billion, and rollovers to other qualified plans would be only $14.7 billion among 8.4 million participants.
Tom Hawkins, vice president of sales and marketing at Retirement Clearinghouse in Charlotte, North Carolina, points out that missing participants have preserved their retirement savings, while participants cashing out have not. A simulation by Retirement Clearinghouse shows that preserving a $5,000 retirement savings balance can result in $70,000 of savings at retirement.
Participants who have cashed out have effectively removed themselves from the defined contribution (DC) system, as if they’d never enrolled, and may also be throwing away their employers’ matching contributions, if that option is part of their plan.
A blog post by Retirement Clearinghouse CEO Spencer Williams explains what it means by “throwing away their employers’ matching contributions.” Typically, these matching contributions are viewed by employees as a tangible, high-value benefit, and by employers as a means to attract and retain the best talent, and improve plan participation and deferral percentage metrics. Cash-outs cause large amounts of employer-matching dollars to go up in smoke, transforming these vested benefits from retirement savings into consumption expenditures, after taxes and penalties are deducted from the payout,” he says.
Using data from its auto-portability simulation as well as findings from a missing participant survey by Boston Research Technologies and Retirement Clearinghouse, Hawkins says far more cashouts occur than participants who go missing. Each year, 14.8 million participants will change jobs. Of these, six million will eventually cash out. (41% of the total). By comparison, only one million participants will remain in their former employer’s plan (14.5% of the total). Of these, about 243,000 (11.3%) will have stale addresses and be considered missing.
He also notes that most 401(k) cashouts are unnecessary. Hawkins cites research done by Boston Research Technologies and Retirement Clearinghouse in 2015, Mobile Workforce Study, which interviewed 5,000 retirement plan participants and found of all people who cashed out their retirement plan balances, only 37% had done so for true financial emergency. Hawkins notes that among other reasons, those who cashed out not for a true financial emergency did so because they had not been educated about the high cost of a cashout and it was the easiest choice since many found the rollover experience difficult.
Focusing on participants cashing out
Currently, under the Employee Retirement Income Security Act (ERISA), DC plan sponsors are allowed to automatically force out participant account balances less than $5,000. For amounts between $1,000 and $5,000, the amounts must be placed in a safe harbor individual retirement account (IRA).
Retirement Clearinghouse, offers an automatic portability solution which uses the demographic data from that rollover, sends it to recordkeepers to see if there is a match in their system and if one is found, automatically rolls over the employee’s IRA account to his new plan.
Neal Ringquist, executive vice president of sales for Retirement Clearinghouse in Charlotte, North Carolina, says having retirement savings in an employer plan is a better choice. Retirement Clearinghouse found that for balances less than $5,000, in the first year after a job change, 55% of participants cashed out, but over seven years for those that remained in the DC system, including the percentage of accounts rolled into an IRA, more than 80% eventually cashed out. “Retaining assets in a DC plan system preserves accounts better,” he says.
Hawkins adds that Retirement Clearinghouse also did research that found participants placed in a safe harbor IRA default investment fund, faced higher fees without a good outcome.
Hawkins points out that the problem of missing participants is a pain point for plan sponsors because it presents a long-term liability for the plan, adds to costs, presents a fiduciary risk and pressure from the DOL to operate in an uncertain environment, with lack of clear guidance. Participant cashouts create no pain point for plan sponsors. However, if plan sponsors care about the retirement readiness of their participants and feel a responsibility to help, cashouts are “a disaster of biblical proportions” for participant retirement savings outcomes.
Retirement savings portability can benefit missing participants, and can also benefit those who cashout; it reduces cashouts by two-thirds among smaller balance participants, according to Hawkins.Ringquist adds that using auto-portability solutions preserves retirement savings for both missing participants and those who cash out, AND can help plan sponsors find missing participants. “A survey done by Warren Cormier of Boston Research Technologies found 67% of missing participants can be matched to current plan accounts,” he says.