You have a new job, and suddenly your world is full of exciting challenges. You need to manage a lot of details in the transition, including your 401(k) account. A proposal by a North Carolina fiduciary company for auto portability might change how you handle 401(k) accounts when job transitions occur.
The Current System
Depending on the employer’s plan, several different things can happen to your money: leave the money in your former employer’s plan, if permitted; roll over the assets to your new employer’s plan, if one is available and rollovers are permitted; roll over to an IRA or cash out the account value. There is a grace period in which your money can sit within the employer’s account. After that grace period, the funds can be automatically transferred to a rollover IRA.
A rollover IRA is just a traditional, pre-tax IRA that is set up to take funds from an employer-sponsored 401(k) account. Another option for balances under $1,000 is for your previous employer to send you a check, minus taxes and penalties. What if you didn’t have to think about your 401(k) account at all?
Retirement Clearinghouse (RHC) has requested an exemption from the DOL in order to create an auto portability program for 401(k) accounts. In essence, the company is building a database of 401(k) participants and their information.
Unless the employee opts out of the plan, their 401(k) will automatically transfer into the new employer’s account.
Benefits of auto portability
How is auto portability better than the current system? Currently, an employer has the option to move balances between $1,000 and $5,000 into a rollover IRA, without the participant’s permission. In order to move the money from this IRA, the participant needs to open another account.
Since this second account is also an IRA, the process creates double the work for an individual. This can create a situation where accounts are forgotten or abandoned. Also, rollover IRAs are set up in a default mode. Essentially, a rollover IRA is a cash account.
Cash accounts have the lowest risk, but they also have the lowest return. Lowest return means your retirement is not growing. Implementation of an auto portability option will streamline retirement accounts, making it easier for participants to keep track of their retirement.
Also, the money follows an employee in a single account. This keeps retirement clean and efficient for employees, particularly those who may have more than one job over the life of their careers. More significantly, automatic transfers of 401(k) accounts will prevent leakage from the retirement system.
On average, 30 percent of people choose to cash out their 401(k) plans when they move jobs. If the participants have less than $5,000 in the account, that average goes up to 80 percent. While 37 percent cash out due to financial hardship, the DOL has found 63 percent cash out, paying penalties and taxes, because it’s the easiest option available.
Implementation of auto portability on balances over $5,000 could increase a participant’s balance at retirement by 25 percent. If auto portability is increased to include balances of less than $5,000, that percentage increases to 35 percent.
The DOL projects the adoption of partial auto portability will increase retirement savings by $256 billion over 10 years, with a total increase of $1.5 trillion over 40 years.
Challenges with auto portability
While the numbers make automatic transfers seem like an obvious choice, there are some potential challenges to consider. Right now, the DOL is reviewing the exemption for one fiduciary company in North Carolina. If adoption becomes broader, there will be difficulties in different recorders and banks tracking information efficiently.
Another concern is auto portability can be viewed as an overreach of authority, both in governmental oversight of retirement accounts as well as the fees associated with auto portability. RHC is requesting an exemption from the ERISA code in which a fiduciary company is prohibited from using its discretion in an action that results in the company receiving a fee.
However, auto portability would allow RCH to charge a fee each time a fund is rolled into a new account.
Despite the challenges in implementation, auto portability would be a benefit for retirement savers, both in the prevention of leakage and in streamlining accounts. Ultimately, auto portability will provide a healthier balance at retirement.
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