Addressing the issue of defined contribution (DC) retirement plan leakage has been a task on which players in the retirement industry have been working for years.
There are already strict requirements for when a DC plan participant can take a hardship withdrawal. It has been recommended that DC plan sponsors limit the number of loans participants can take or limit the accounts from which they can take loans. It has also been noted that there is nothing in the law that says participants must pay loans in full upon termination of employment, but the problem with allowing ex-participants to continue to make repayments may be with the recordkeeper.
However, hardship withdrawals and participant loans are not the biggest leakage problem DC plans have. “Without a doubt, cashouts are biggest portion of retirement plan leakage,” says Employee Benefit Research Institute (EBRI) Research Director Jack VanDerhei, based in Washington, D.C. An analysis conducted by VanDerhei for EBRI in 2014 found approximately two-thirds of the leakage impact is associated with cashouts that sometimes occur at job change.
A demonstration provided by Retirement Clearinghouse 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. Its analysis did not include appreciation, so these amounts would be larger if average returns were included. Retirement Clearinghouse has introduced an innovation that it hopes could change these numbers.
NEXT: Introducing auto-portability
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).
Spencer Williams, president and CEO of Retirement Clearinghouse, explains that its automatic portability solution would use the demographic data from that rollover, send it to recordkeepers to see if there is a match in their system and if one is found, automatically rollover the employee’s IRA account to his new plan.
Retirement Clearinghouse’s demonstration shows that in just more than 30 years, under auto-portability, cashouts would be reduced to $144.3 billion, and rollovers would be $133.5 billion among 77.5 million participants.
VanDerhei says until there is legislation to address cashouts, automatic roll-ins are the best way of trying to do something that will use employees’ inertia for their own good. “If we can link those relatively small amounts from the past employer to the future employer, we’ve seen over and over the size of the account balance increases,” he tells PLANSPONSOR. “And if we can get employees’ balances up to a sweet spot for a particular age, they will see their balances as significant enough to not take out of the plan.” Williams says that sweet spot starts at $10,000 and goes up to $20,000.
“The probability of cashing out drops from 90% to 30% when a participant’s account goes over $20,000,” Williams tells PLANSPONSOR. He notes that auto-portability can help participant accounts get to $20,000 much sooner, and it also makes rollovers easier for participants.”NEXT: Regulations, legislation and employee education
VanDerhei says he has no knowledge of anyone trying to address the cashout problem legislatively. This past summer, the Bipartisan Policy Center’s Commission on Retirement Security and Personal Savings issued a report recommending that to prevent leakage from retirement plans, policymakers must ease the process for transferring savings from plan to plan. But, VanDerhei says just because the Bipartisan Policy Center made proposals for addressing the DC retirement system’s problems doesn’t mean anyone will try to issue a legislative package for all or any of its suggestions.
The Internal Revenue Service (IRS), however, has made attempts to make the plan-to-plan rollover process easier: by introducing an easy way for a receiving plan to confirm the sending plan’s tax-qualified status; issuing new guidance for allocating pre-tax and after-tax amounts among distributions that are made to multiple destinations from a qualified plan; and introducing a new self-certification procedure designed to help recipients of retirement plan distributions who inadvertently miss the 60-day time limit for properly rolling these amounts into another retirement plan.
VanDerhei says employees do get frustrated with what they have to do to rollover their assets to a new plan, so making that easier is key.
However, he also notes that with the new financial wellness interest among employers, information directed at a DC plan participant at the point of termination of employment could have an impact. “If they realize what [cashing out] will cost them in the long run and how it will affect their total retirement savings, it could modify the behavior of some participants,” VanDerhei says. He adds, however, that there are some people, no matter what the plan sponsor does or says, who need the money and will cash out.
“In any case, automatic provisions trump anything plan sponsors can do with education,” VanDerhei concludes. “It will still allow employees access to their cash if they need it, but the default will be best for them in the long run.”