What the Pension Protection Act has taught us about saving for retirement

They say that hindsight is 20/20. And as we look back on the Pension Protection Act, which was passed just over 15 years ago, it’s clear that our understanding of the law has, well, cleared up.

Commendably, this legislation was crafted with the best of intentions — to help more Americans save for retirement — but its unintended consequences made a greater impact for too long.

Among other provisions, the Pension Protection Act gave plan sponsors the power to automatically enroll employees in their 401(k) plans. But high workforce mobility, coupled with a lack of seamless plan-to-plan asset portability solutions for job-changing participants, led to an unintended consequence: a sharp uptick in small, stranded 401(k) savings accounts.

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Two data points illustrate the enormity of the problem inadvertently created by auto enrollment. First, at year-end 2015, 41.3% of plan participants in the Employee Benefit Research Institute/Investment Company Institute 401(k) database had 401(k) savings account balances of under $10,000. This was the highest percentage of participants in the database with 401(k) account balances below $10,000 since year-end 2008.

And second, the number of active participant accounts with under $15,000 rose from 23.5 million in 2005 to 31.6 million in 2015, according to the EBRI/ICI database and U.S. Department of Labor’s Private Pension database. This jump of 34.5% represents, on average, an increase of 735,841 small 401(k) accounts per year during that decade.

The complex, time-consuming, and expensive process of DIY plan-to-plan asset portability made leaving accounts behind one of the two least complicated options (along with cashing out) for many participants at the point when they change jobs. The proliferation of small accounts has led to, among other things, higher expenses for participants that can affect their retirement outcomes.

If we use data from New England Pension Consultants, which reported that the median record-keeping fee for defined contribution plan participants was $59 in 2017, then a hypothetical 30-year-old worker who leaves behind a 401(k) savings account in their former employer’s plan would forfeit $2,124 in fees paid on that account by age 65, assuming the account grows by 7% per year.

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But in addition to account fees, the hypothetical participant would also lose future earnings from compound interest on the $2,124 in fees — increasing the amount of lost savings to $8,785.89 by age 65, again assuming a 7% annual rate of return.

The average American worker saving for retirement will switch jobs 9.9 times during a 45-year working life, according to EBRI. If leaving behind just one 401(k) account at the point of job-change can cause participants to lose nearly $9,000, imagine what impact nine stranded accounts can have on retirement prospects.

The increase of these small accounts has also had a negative effect on plan sponsors. More small accounts decrease average account balance and other key plan metrics. They also increase the fiduciary liability to which sponsors are exposed. However, the massive increase in small accounts has benefited plan recordkeepers, having pushed their revenue model toward one that is based on the number of accounts in a plan as opposed to assets under management.

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Fortunately, over the past 15 years, the private and public sectors have worked together to create solutions that simplify the process of transporting 401(k) savings from one plan to another when participants change employers.

Their focus has been on auto portability, the routine, standardized and automated movement of a retirement plan participant’s 401(k) savings account with less than $5,000 from their former employer’s plan to an active account in their current employer’s plan. This solution, which has been around for more than four years, utilizes a “match” algorithm and “locate” technology to roll participants’ stranded 401(k) account balances or safe-harbor IRA accounts into active accounts in their current employers’ plans.

Auto portability has a track record of increasing the average account balance of a plan’s participants. Only four months after implementing this approach, a large plan sponsor in the healthcare services industry increased the average account balance of its participants by 48%, as per a 2017 case study by Boston Research Group.

Furthermore, EBRI estimates that, in the event auto portability is broadly implemented across a 40-year period, up to $2 trillion (measured in today’s dollars) in additional savings would be preserved in the U.S. retirement system. This amount would include about $191 billion in extra retirement savings for 21 million Black Americans and $619 billion for all minority participants.

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Besides the development and availability of auto portability, another positive trend has emerged. The primary default investment option for many defined contribution plans 15 years ago was the money market fund, just as we see in safe-harbor IRAs that are used to remove small accounts from plans today, with low returns that impact participant outcomes.

The Pension Protection Act, however, made it acceptable for target-date funds to become the primary default investment option in plans — which is a better savings option for participants. This is another reason why consolidating retirement balances into participants’ new-employer plans automatically, upon job-change, makes sense.

Finally, more than 15 years after the Pension Protection Act, we now have the tools to achieve the main goal of this legislation: helping more Americans participate in the U.S. retirement system and save more for retirement.