Why dump mandatory distributions in a landfill when you can recycle?

Commentary: Mandatory distributions of small 401(k) accounts when participants separate from service provide many benefits for plan sponsors, including lower administrative costs and higher average account balances. However, these “automatic rollovers” also indirectly cause billions of dollars to leak out of the U.S. retirement system every year through cash-outs.

Sponsors that concentrate on rollovers without using their roll-in features are sub-optimizing their plan’s effectiveness — and hurting the U.S. retirement system — by creating a bigger landfill for stranded and cashed-out retirement savings, rather than recycling participants’ savings back into their current employer plans as they change jobs. 

Plan sponsors can help themselves — and remedy the scourge of cash-outs — by more fully utilizing the roll-in feature embedded in their plans to create an automated, two-way flow of accounts both into and out of their plans. By positioning their plans to automatically accept the small account balances of new and current employees, “automated portability” enables sponsors to systematically swap separated participants’ small accounts for larger balances in their active participants’ accounts.

Also see: DIY plan-to-plan portability is harder than you think

Sponsors that focus solely on one-way flows for the purposes of rolling small 401(k) balances out of their plans are missing out on an easy and cost-effective opportunity to further enhance their plans while improving the retirement readiness of their active and separated participants.

The evidence

Roll-in features are largely ignored — a 2013 Plan Sponsor Council of America survey found that 98.4% of 401(k) plans accept rollovers from other plans. In contrast, the Employee Benefit Research Institute found that only 0.5% of separated participants’ assets transferred into their new or current employers’ plans in 2012. Talk about a gap!

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

At the same time, leakage is reaching epidemic proportions — cash-outs remove more than $1 trillion from future retirement income streams. A November 2014 report prepared by the ERISA Advisory Council included testimony from Warren Cormier, CEO of Boston Research Technologies and co-founder of the RAND Behavioral Finance Forum, who noted that 45% of plan participants cash out their 401(k) accounts when they change plans.  

Conversely, EBRI estimates that a 50% reduction in cash-outs across the board would increase total retirement savings by about $1.3 trillion, and the widespread reduction of multiple savings accounts could save consumers $40 billion in administrative expenses over a 10-year period.

David Wray, former president of PSCA,  declared in the July/August 2012 issue of the organization’s magazine that “it is in everyone’s interest to aggregate account balances as an employee changes jobs.” The ERISA Advisory Council echoed this sentiment, and recommended that the U.S. Department of Labor help sponsors overcome obstacles to the electronic two-way transfer and consolidation of retirement savings.

Also see: 5 retirement plan resolutions for 2015

A Boston Research Group case study from 2013 found that a systematic approach to encouraging and enabling two-way flows cut cash-outs at one of the largest U.S. health care providers by over 50%, and increased the average account balance in the plan by 57.8%.  

Do you want to add to an already sizable landfill, or do you want to recycle? Like the recycling of paper, glass and plastic, the recycling of retirement savings through automated portability benefits everyone and is easy to implement. All it takes is a small change to your existing approach to mandatory distributions/automatic rollovers.

Spencer Williams is president and CEO of Retirement Clearinghouse.