JGI | Jamie Grill | mix pictures | Getty
401(k) plans include a whopping $7.7 trillion in retirement savings. But withdrawals from small accounts pull billions out of the system each year and can hurt investors’ chances of a safe retirement, research shows.
A trio of the industry’s biggest 401(k) administrators – Fidelity Investments, Vanguard Group and Alight Solutions – have come together to change that.
Along with Retirement Clearinghouse, they formed a consortium – Portability Services Network, LLC – to automatically reconnect workers to old 401(k) accounts that they may have lost or left behind after leaving work.
The partnership, which the companies describe as a first of its kind for the industry, aims to fix what they see as structural flaws in the current pension system.
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If employees leave 401(k) accounts with less than $1,000, current rules allow employers to withdraw the funds and write a check. That payout can come with taxes and penalties if you don’t move the money to a new qualifying retirement plan within a short window of time.
Employers generally cannot cash out accounts of $1,000 or more. But they can move those with $1,000 to $5,000 from a 401(k) to an individual retirement account, where — unless the employee takes action — monies are often invested in cash on their behalf by default, a strategy unrelated to construction A nest egg is compatible for decades, experts said
Employee and employer-initiated payouts are a “serious problem” that resulted in $92.4 billion in 401(k) plan outflows in 2015, according to the latest data from the Employee Benefit Research Institute.
Automatically reconnecting workers with accounts with less than $5,000 could save $1.5 trillion remaining in the pension system over 40 years, according to the EBRI.
“Billions of dollars are left behind or simply paid out, and [workers] pay taxes on it and spend it, which isn’t good for their long-term retirement savings,” said Philip Chao, a board-certified financial planner and founder of Experiential Wealth in Cabin John, Maryland.
How the new consortium will work
This is where the new consortium of plan administrators is focusing its efforts. If an employee changes jobs and has $5,000 or less in their account, Fidelity, Vanguard and Alight will automatically move 401(k) assets to the employee’s new work schedule, if possible. Basically, money follows the worker.
The worker can choose to withdraw at this point, although Dave Gray, Fidelity’s head of employee benefit platforms, expects more than 90% of the money invested to keep.
And it’s not just 401(k) balances — the transfers also apply to similar workplace plans outside of the private sector, including 403(b), 401(a), and 457 plans. Women, minorities and low-income savers will benefit the most as they disproportionately have account balances of less than $5,000, Gray said.
“This money is important and vital,” he said.
One payoff in an investor’s lifetime increases the likelihood of running out of money in retirement by an average of 11.4 percentage points to 30.4%; two or more raise the rate to 46.4%, according to the EBRI.
From today’s perspective, there’s a flaw: The only way companies can facilitate the transaction is when workers move to or from an employer with a retirement plan managed by Fidelity, Vanguard, or Alight.
“If the participant moves outside of the universe of these three companies, they haven’t really improved the outcome,” Chao said.
Companies account for around 44 million occupational pension savers or around 40% of the market. They work in tandem with 48,000 employer-sponsored retirement plans.
Their goal is to expand the list of companies in the consortium to increase the number of investors who can benefit.
Contain “leaks” as auto-enrollment after 401(k) increases
Martin Leigh | Image source | Getty Images
So-called “leaks” from the pension system due to payouts have become a more pervasive problem as workers change jobs more frequently and more employers automatically enroll workers in their company’s 401(k), Chao said. The latter dynamic increases the number of savers overall, but can also create many small accounts that their owners are unaware of.
The Retirement Clearinghouse serves as an engine that facilitates transfers between administrators and will manage day-to-day operations, Gray said. The companies charge workers a one-time fee for the service: 5% of the account balance, up to a maximum of $30. Accounts with less than $50 will not be charged.
The fee is expected to decrease over time, Gray said. The service is intended as a utility for retirees and the consortium is operating at a break-even price, he added.
Administrators can also benefit from keeping more money in the system. Many companies generate income based on a percentage of assets in a retirement plan; If more money stayed in the system, more revenue would likely follow.
But the industry has shifted from an asset-based charging model to one that charges based on the total number of investors in a plan, meaning the new service isn’t necessarily a “financial win” for administrators, Gray said.