Safe harbor IRAs aren’t always safe

Commentary: Plan sponsors can help themselves and their participants over the long term by rolling balances of $5,000 or less from inactive participants into safe harbor IRAs. However, for various reasons, many safe harbor IRAs don’t live up to their name and could leave sponsors with unexpected fiduciary liability.

The best way for sponsors to avoid exposure to this liability is to choose an automatic rollover (ARO) provider that offers a fiduciary-friendly fee schedule and has a proven track record of moving safe harbor IRAs forward to account holders’ active 401(k)s. Constructing an ARO program with these features validates that sponsors are serving the best interests of participants, and making every effort to protect even very-small-balance participants’ hard-earned savings. 

Fees matter most to small-balance accounts

In a prior blog post, we demonstrated that account fees assessed on a monthly basis (versus annually) can reduce the total fees charged to safe harbor IRAs by approximately 25% — but the fee savings shouldn’t stop there. In addition to monthly fees, a well-structured ARO program should also accept even the smallest accounts — specifically those with less than $1,000 — as well as institute a progressive fee schedule for those smallest of accounts.

Also see: Reduce plan fees by increasing account balances

Sponsors should give strong consideration to adopting a plan amendment that permits inactive accounts with less than $1,000 to roll over to a safe harbor IRA, instead of automatically cashing them out. A sponsor’s decision to cash out small accounts imposes both taxes and penalties on these participants’ retirement savings. In addition, a plan that automatically cashes out accounts with less than $1,000 is basically telling participants their savings don’t matter, a message that runs counter to the spirit and intent of a retirement savings plan — as well as a sponsor’s responsibility as a fiduciary.

Instead of cashing out these small balances, sponsors should alter their ARO programs so that all accounts will be automatically rolled over to safe harbor IRAs, regardless of their balances. As a side benefit, automatically rolling over accounts of all sizes reduces the headaches that come with uncashed checks.

Also see: How auto-enrollment can be enhanced with auto-portability

Progressive pricing makes safe harbor IRAs ‘safer’

Performance expectations for safe harbor IRAs are so low that many consultants use a metric called the ‘rate of decay’ to help sponsors evaluate them! Since current interest rates ensure that most safe harbor IRAs will likely accrue higher fees than returns, the rate of decay essentially asks, “How many years will the balance of a safe harbor IRA account remain positive given this provider’s fees?”

However, significant decay doesn’t have to be a fait accomplifor safe harbor IRA accounts. ARO providers can apply progressive pricing methods designed to save account holders money. For example, at Retirement Clearinghouse, if a safe harbor IRA balance is below a certain amount, fees begin to decrease in proportion to the account balance.

Also see: Add ‘consolidation’ to the script for improving plan metrics

By employing both low-tech and high-tech features, a well-structured ARO program can further prevent excessive account depletion. Low-tech is simply good service: as documented by Boston Research Technologies, requiring participants to speak to a counselor will cut the incidence of cash-outs by more than 50%. High-tech is even better: using an electronic-record-matching process, an ARO program can proactively locate a safe harbor IRA account holder’s active plan and then automatically roll his/her 401(k) balance into the current employer’s plan. This seamless transfer is enabled by auto-portability.  

Plan participants appreciate sponsors that facilitate auto-portability and provide other assistance with account consolidation. In a recent study authored by Warren Cormier, CEO of Boston Research Technologies, 46% of participants described account roll-in services as “an excellent benefit” compared to other offerings, and an additional 47% of participants said roll-in services are “a good benefit.”

These findings offer a good heads-up moment for plan sponsors. Take notice and make your choice of safe harbor IRAs safer by adopting a program that offers a full array of protections — both for your plans and for those inactive participants who are forced out of your plans.

Spencer Williams is president and CEO of Retirement Clearinghouse.