Addressing Forgotten Accounts Can Improve Retirement Savings Outcomes
“Lost” or forgotten defined contribution (DC) retirement plan accounts can have a major negative effect on retirement savings outcomes for individuals.
Research from Capitalize, a fintech company that consolidates 401(k) accounts into a new or existing employer-sponsored plan or individual retirement account (IRA), finds there are 24.3 million forgotten 401(k) accounts in the U.S. with approximately $1.35 trillion of assets in them, representing 20% of the $6.7 trillion total assets in 401(k) plans. For its research, Capitalize used the Department of Labor (DOL) Form 5500 database, which includes data from 2018. From there, it estimated the number of additional forgotten 401(k) accounts since then.
Combining data from the DOL’s Form 5500 database, Vanguard and the U.S. Census Bureau’s Survey of Income and Program Participation (SIPP), Capitalize estimates that the average balance in forgotten 401(k) accounts in 2018 was $55,000.
One might understand forgetting about a $2,500 balance that was automatically forced out of a DC plan into a safe-harbor IRA, but it seems harder to forget about $55,000. However, Gaurav Sharma, co-founder and chief executive officer (CEO) at Capitalize, explains that the eye-popping figures are due to a broad definition of “forgotten” accounts to include accounts that participants have disengaged from.
“We were surprised as well to find that the average balance in forgotten accounts is higher than we would assume,” Sharma says. He explains that the term “forgotten” when it comes to retirement plan accounts doesn’t just include those accounts people don’t remember they have. “People leave money behind in old plans or IRAs, and even if they know it’s there, they don’t engage with it and have lost track of fees and investment options. If they are asked what they know about a prior 401(k), they don’t know much about it,” Sharma says.
Capitalize estimates that savers could be missing out on a combined $116 billion in additional retirement savings each year.
Sharma attributes the growing problem to the complex process of consolidating or rolling over DC plan accounts or IRAs. For example, a 2019 survey by Financial Engines found half of participants were unaware they could move money from their IRA to a 401(k). Rollovers rules vary between plan types, and education could be helpful for both plan sponsors and participants.
Benefits of Retirement Account Consolidation
Plan sponsors are allowed to force out balances below $5,000; those between $1,000 and $5,000 must be rolled into a safe-harbor IRA.
Using the same math for a $2,500 balance left in an old DC plan or moved to a high-fee safe harbor IRA, Sharma calculates that total foregone savings could total more than $31,000 over 30 years. This projection assumes the forgotten account incurs an annual fee of 0.85% and returns 1.00% annually, and that no more contributions were made to the account over the years. Sharma says the alternative option—a well-optimized retirement account—charges an annual fee of 0.40% and returns 9.2% annually.
There are benefits to consolidating retirement savings accounts, says Sharma. He notes that it is hard to manage retirement savings among many different accounts, keeping up with fees and investments.
Sharma says money moved to a safe harbor IRA is often defaulted into low-risk investments such as money market funds because of the fiduciary duties involved. A 2019 Issue Brief from the Employee Benefit Research Institute (EBRI) found this to be true. Savings moved to a safe harbor IRA would generate a lower outcome for participants compared to savings rolled over to another employer’s retirement account that would generate higher returns with lower fees, Sharma adds.
By ignoring prior accounts, over time, the investment strategy might not match what a participant needs, Neal Ringquist, executive vice president and chief of sales at Retirement Clearinghouse, notes. For example, the savings in a prior plan might be invested aggressively because the participant was younger then, but now they should be invested more conservatively.
Spencer Williams, president and CEO of Retirement Clearinghouse, contends that the biggest risk of not paying attention to prior plan accounts is investment risk. “Investments are dynamic, and rebalancing is a staple of maintaining a saver’s investment profile,” he explains. “Without rebalancing, people could get greater exposure to the wrong investments at the wrong time and have an investment allocation that goes against their investment philosophy.” Williams adds that this problem is greater when a person gets closer to retirement age.
“In any one plan, participants can get proper investment diversification, so they don’t need multiple accounts,” Ringquist adds. “In retirement accounts with the same tax status, participants are not getting tax diversification, so there’s no real diversification benefit of multiple accounts. However, the benefits of consolidation are the ease of management and the elimination of redundant fees which will improve returns.”
Having multiple retirement accounts also complicates withdrawal decisions at retirement, Williams says. “We see that a lot; participants who get to retirement age trying to pull all their assets together. Doing so regularly as they move through their career is a better approach,” he says.
Spencer Williams, president and CEO of Retirement Clearinghouse, notes that consolidating retirement accounts also reduces exposure to cybersecurity risk. “The more financial accounts a person has, the more likely fraud will happen,” he says. Williams notes that Retirement Clearinghouse will be performing the roll in service for the Federal Thrift Savings Plan (TSP) next May as part of the TSP’s upgrade.
How Plan Sponsors Can Mitigate the Forgotten Accounts Problem
One way plan sponsors can help is to provide user friendly tools and education about what to do with DC plan account balances, Sharma says. “It will require a mindset shift of helping people make the most of their money, not just when they join a plan but when they leave,” he says.
Sharma points out that generally much less attention is given to employees who leave than when employers are onboarding a new hire. “When people leave [an employer], they are given disclosures and legalese—very dense paperwork—it might go into a drawer or the trash and not be looked at,” he says. “We provide an offboarding service for free to plan sponsors and terminating participants. Terminating employees are presented with the Capitalize platform as a way to seamlessly roll over their retirement accounts, but some people still might decide to leave their savings in the prior employer’s plan and some may need to cash out.”
Capitalize helps retirement savers locate old 401(k) accounts, compare IRA providers and roll the accounts over into an IRA of choice. Sharma says the rollover process is very paper-based and cumbersome and people don’t understand the process and are put off by the difficulty. “We put the process online and make it easy,” he says.
Ringquist says one way to look at it is that one plan’s terminated participant is another plan’s new hire, so plan sponsors can help participants who leave their plans as well as those entering their plans.
Ringquist says that first, it’s imperative that plan sponsors attempt to maintain current addresses with which to communicate to participants who leave. “They need to make sure the lines of communication are open,” he says.
Secondly, Ringquist suggests that plan sponsors have a program—at a minimum an educational program, but ideally a service—that communicates the benefits of account consolidation in an unbiased way. Plan sponsors could do that purely through education, but many plans have an adviser in place to help participants with decisions and some use a transaction engine that will help facilitate a rollover once a decision is made.
One solution to end having missing participants and forgotten accounts at the small time is for a plan sponsor to adopt auto portability, Ringquist says. An advisory opinion and prohibited transaction exemption from the Department of Labor (DOL) cleared the way for automatic portability programs in which retirement savings accounts can be automatically rolled from one plan to another for participants who terminate employment. The DOL’s actions were specific to Retirement Clearinghouse’s system.
With new hires, plan sponsors should encourage consolidation into their plans, if rollovers are allowed, Ringquist says. He notes that Plan Sponsor Council of America (PSCA) data shows around 96% of plans allow rollovers from other plans, but only two-thirds allow rollovers from IRAs. He suggests that plan sponsors consider making rollovers from IRAs permissible for participants, especially with more state-based auto-IRA programs being established.
Ringquist says the messaging for new hires should be about the benefits of consolidating retirement savings into one plan. In addition, plan sponsors should make sure new hires are familiar with the plan recordkeeper’s or a third-party’s system to facilitate rollovers.
Sharma notes that helping employees with accounts when they terminate is also in the best interest of plan sponsors. It can reduce per-participant or asset-based fees charged by service providers, as well as compliance obligations under the Employee Retirement Income Security Act (ERISA) that extend to terminated participants.
For plan sponsors, addressing forgotten accounts is also important because the DOL is “clearly on a path of expecting a due diligence process-driven approach to finding missing participants,” Williams says. “The expectation has moved to a point of having a regular program or process in place, kind of like the discipline structure of reviewing investments.”
“The most important thing, though,” Sharma says, “is to make sure participants don’t squander savings they’ve worked hard to accumulate.”
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