Might ‘Auto Portability’ Reduce 401(k) ‘Leakage’?

Cashing out when changing jobs, not taking loans, diminishes savings most

Stephen Miller, CEBS By Stephen Miller, CEBS August 17, 2016
Might ‘Auto Portability’ Reduce 401(k) ‘Leakage’?

When workers take out take out loans from their retirement plans, make hardship withdrawals or cash out when they change jobs, they create "leaks" that drain away their retirement savings.

Experts met recently at a forum in Washington, D.C., hosted by the nonprofit Employee Benefit Research Institute (EBRI), to discuss ways to counter this leakage. As summarized in the August issue of EBRI Notes, presenters made these key points:

  • Proposals to address leakage, such as placing restrictions on loan-taking, may have unintended consequences. For many workers, the option of being able to take a loan from their 401(k) account is seen as a major incentive for them to participate.

  • 401(k) loans, which sometimes are criticized as a significant source of retirement savings leakage, actually account for the smallest amount of preretirement savings loss. An EBRI analysis found that approximately two-thirds of the impact of diminished retirement savings due to leakage was associated with pre-retirement cash-outs, which occur when participants change or lose their jobs.

A New Approach

As workers change jobs, automated transfers of retirement savings from their 401(k) plan to an individual retirement account (IRA) or to their new employer's 401(k) plan could significantly reduce leakage, according to a presentation at the forum.

J. Spencer Williams, president and CEO of the Retirement Clearinghouse (RCH), a Charlotte, N.C.-based provider of portability services for plan sponsors, noted that about 12.5 million Americans with defined contribution plans change jobs each year—and approximately 5 million of them have retirement accounts with less than $5,000. They face the decision of what to do with their retirement savings. Based on his analysis of data from EBRI and other sources:

  • About 37 percent of job-changing workers cash out because they need the money, while the remaining 63 percent who take money out of their retirement accounts do so because "it's the easiest path available," despite the penalty and taxes they will have to pay, Williams said. Taking funds out of the plan instead of transferring them to another qualified plan triggers a withdrawal penalty if distributions are made before age 59½. Income taxes also must be paid on distributions from a traditional (non-Roth) 401(k) plan.

  • The large majority of job changers go to a new employer that also offers a 401(k) plan. About 16 percent of job-changers with small accounts go to an employer that does not have a 401(k) plan but later switch to a new employer that does.

"We know from behavioral studies that this population of job changers, particularly with very small balances, is inert. They really don't respond" to education efforts aimed at retirement plan participants, Williams said. Instead, "they cash out."

But just as automatic enrollment has increased plan participation rates by requiring employees to proactively opt out if they don't want to participate in the plan, so too could "auto portability" help solve the problem of employees cashing out when changing jobs, Williams said.

The essence of the auto portability approach, he explained, is to create a mechanism of electronic records-matching for individuals between their former employer's retirement plan and the new employer's plan so that their retirement savings are automatically transferred.

Two major technical problems with auto portability have been achieving cooperation among 401(k) recordkeepers and getting the U.S. Department of Labor to agree with the "negative consent" provision, under which employers presume the participant wants to transfer funds, unless the participant actively chooses to withdraw the funds, he said.

Initial Success

Williams noted that "this is not just a concept," as auto portability is currently being provided to employers that are RCH plan sponsor clients. These organizations allow new hires to opt out but otherwise seek to have the employees' 401(k) account balances from their former employer transferred into the new plan.

Of the 1,500 retirement plan participants whose accounts have been automatically transferred, "the measured average account balance in the [new] employer plan increases by about 45 percent," Williams said. "By creating this default path, we incubate those savings accounts."

A June 2016 report by the Bipartisan Policy Center, a Washington, D.C.-based nonprofit policy institute, recommended adopting processes that enable the seamless transfer of retirement savings between defined contribution plans when participants change jobs. The report, Securing Our Financial Future, noted that these solutions can increase retirement savings by reducing cash-outs and early withdrawals by plan participants, "who are most vulnerable to making these destructive decisions at the point of job-change."



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