The safe-harbor IRA: friend or foe?

Automatic rollovers of small, stranded 401(k) savings accounts are, on the surface, helpful for plan sponsors to keep their plans lean and healthy. However, “on the surface” is the key part of the previous sentence.

While sponsors can deploy automatic rollovers (AROs) to kick small 401(k) accounts out of their plans, the participants who hold those accounts don’t benefit at all — in fact, if they don’t cash out their savings entirely, they can be stuck with multiple accounts that incur fees that deplete their savings over the long term. By continuing to engage in practices that, though legal, could be harmful to participants, sponsors may be opening themselves up to fiduciary liability.

Think about it. Is a small-balance account better off in a safe-harbor IRA, or in an active account in the participant’s current-employer plan? As things stand today, sponsors are within their rights to move terminated-participant accounts with less than $5,000 into safe-harbor IRAs via the ARO process, and they don’t need to receive consent from participants to do so.

But as I’ve written in this space before, safe-harbor IRAs don’t always live up to their name. In addition to generally offering poorly performing investment options, as they are required to be invested in principal-protected products, safe-harbor IRAs also stick participants with potentially high administration fees. High fees and low returns mean safe-harbor IRA accounts deplete retirement savings without the consent of the participant. If lost or missing participants don’t know their stranded 401(k) account balance has been moved to a safe-harbor IRA, and their hard-earned savings continue to sit in the account for a long time, their retirement savings could be depleted to zero.

Similarly, sponsors that continue to automatically cash out small terminated-participant accounts with less than $1,000 help themselves at the expense of participants. Automatic cash-outs deprive participants of the opportunity to preserve those under-$1,000 sums in the U.S. retirement system, thereby forcing them to forfeit the extra savings they would have accrued by doing so. In addition, if the accountholder whose small balance is cashed out has moved, and never updated their address with the sponsor’s record-keeper, then they might not even receive the check. These scenarios also expose sponsors to potential liability. Bottom line: a plan sponsor’s fiduciary responsibility for looking after the best interest of participants under ERISA regulations does not have an account-balance size requirement.

Auto portability resolves these quandaries

Are small-balance participants better off paying a one-time fee of around $45, plus an annual, recurring $40 (or more) fee following an ARO, plus a 5% recordkeeping fee (based on a $1,679 average balance) for an account subject to a mandatory distribution? Or are they better off paying an average recordkeeping fee of 0.59% (based on a 2017 NEPC study) by having their savings moved to their current-employer plan?

Are they better off investing their long-term retirement savings in money market funds, or target date funds with significantly better historic long-term returns?

Are they better off losing track of their small balances, and the extra savings they might have accrued, because they never updated their addresses with former-employer plan recordkeepers, or having those assets follow them to a new-employer plan whose recordkeeper likely has their current address on file?

We all know the answers to these questions.

Thankfully, we are at the point where AROs are capable of delivering truly better options to small-balance participants. All sponsors need to do is to implement auto portability as part of their ARO programs.

Auto portability is the routine, standardized, and automated movement of a retirement plan participant’s 401(k) savings account from their former employer’s plan to an active account in their current employer’s plan. By seamlessly moving small terminated-participant accounts into participants’ 401(k) accounts in their current-employer plans, auto portability helps sponsors deliver positive retirement outcomes for those participants.

Underpinned by complementary “locate” technology and a “match” algorithm, auto portability identifies an inactive participant account — which could also be a lost or missing participant’s account — and initiates a process to move the account into a participant’s current-employer plan. Auto portability not only eliminates the need for dumping small accounts into safe-harbor IRAs, but also erases the multiple ongoing fees associated with AROs into safe-harbor IRAs.

The widespread adoption of auto portability would also confine automatic cash-outs of accounts with less than $1,000 to the dustbin of history.

By making it easy to locate lost/missing participants and facilitate plan-to-plan portability for small accounts — thereby allowing small accounts to be saved and consolidated in the U.S. retirement system — auto portability would preserve up to $1.5 trillion, measured in today’s dollars, in retirement savings, according to Employee Benefit Research Institute (EBRI) estimates. Fortunately, auto portability has been live for more than two years, and is readily available for plan sponsors to optimize their ARO programs.

A plan sponsor’s fiduciary duty to participants is not driven by account balance. Participants with less than $5,000 in 401(k) account savings are just as entitled to options in their best interest as participants with much higher balances.

Employers which truly embrace the principles of financial wellness will implement processes to ensure all participants in their defined contribution plans see their hard-earned assets wind up where they are better off — in accounts in their current-employer plans, as opposed to safe-harbor IRAs.