Automated practices within 401(k) plans—auto-enrollment, auto-escalation and qualified default investment accounts—have proven successful. To many in the industry, auto-portability is the next logical step. In December 2018 the DOL issued two guidance documents related to auto-portability: an advisory opinion and a notice of proposed exemption. In mid-July, observers expected finalized guidance from the Department of Labor (DOL) within weeks.
Their predictions were proven accurate when the DOL issued their finalized transaction exemption 2019-02, on July 31, which clarified the participant-protective “guardrails” that fintech firm Retirement Clearinghouse (RCH) must follow in executing their auto-portability program, since the firm earns a fee for the consolidation of participants’ balances.
An underlying motivation for auto-portability is what Spencer Williams, president and CEO of Retirement Clearinghouse, calls the small account problem. The issue has two facets: missing participants and small balances. In some industries, employees tend to change jobs frequently. Auto-enrollment gets them into the employer’s plan, but the employee doesn’t stay on the job long enough to save much in the account. Consequently, departing employees may forget to give the former plan sponsor their new address. From the sponsor’s perspective, the participant has gone missing and the plan is stuck with a small account—or more likely, multiple employees’ small accounts—that incur administrative costs.
This has been a large problem for many plan sponsors, according to Michael Kreps, an attorney and principal with Groom Law Group. “Every company has turnover, people leave, they disappear and, then, you can’t find them,” he says. “And, so, you’ve got money in your 401(k) plan or your pension and that money is just sitting there, you have no idea how to contact the people, you can’t find them.” However, he adds, the DOL’s position is that the plan has some obligation to locate these participants, creating another administrative burden and cost for the plan.
Workforce mobility among smaller-balance participants also feeds into premature cash-outs of account balances. Numerous studies have shown the detrimental impact of taking premature distributions on retirement finances because long-term compounding benefits are diminished. “We have people cashing out their retirement savings when they change jobs and you do that once, twice, three times very early in your career that has implications for you on the back end on retirement,” says Kreps.
Auto-portability could help address this problem by improving what Williams calls “account incubation.” He cites behavioral finance research findings that participants with higher account balances are less likely to cash out, so preserving smaller balances can lead to better financial behavior. “If we can keep that $2,000 account balance and roll it forward and do that two or three times over the first decade of an individual’s career, all of a sudden they have a meaningful retirement account,” he says. “Their inclination to cash out or do something stupid with the money drops like a stone.”
Plans’ experiences with other automated features suggests that auto-portability could take advantage of the same behavioral patterns, Kreps notes. The account balance will automatically follow the participant to the new plan, unless the participant opts out, allowing positive inertia to guide decisions. “It’s harder to get up and do something than it is to have somebody just let something happen,” says Kreps. “So, it should prevent cash outs materially.”
Sponsors reap two benefits from auto-portability, Williams maintains. Those who lose participants due to job changes can simultaneously avoid the missing participant problem and get smaller balances off their books. RCH’s technology, for example, can roll the departing employee’s balance into an IRA. After the employee starts a new job and enrolls in that company’s plan, the funds would be rolled over to the new plan.
That outcome further benefits the new plan, Williams adds. New hires typically start with regular payroll-based contributions. These amounts are small and create more small-balance accounts for the plan. Transferring in new hires’ previously accumulated funds helps accounts grow more quickly. He gives the example of the new employee who starts saving with a $100 contribution. “Think about the circumstance where that new hire’s money from a prior employer followed them into the plan and it’s $2,000,” he says. “So, on Day One, instead of $100, they have $2,100 in the account and it grows from there. The employer wins on both ends of auto-portability. They win because they get rid of the small account for the person who is no longer employed, and they win because they get more money opening up a new account balance for the new hire.”
Ready to Roll
While the industry was waiting for the DOL’s final guidance, auto-portability technology was already proving its value, says Williams. He cites the experience of an RCH client in the hospital services industry with high workforce turnover. “We have been able to successfully locate and match over 6,000 accounts that belong to active participants in their plan,” he reports. “The technology is working today, the automation is working today, we were just waiting for Labor to finish the opinions, and then, we push it out into the market on a wholesale basis.”