Policy changes look to reduce 401(k) plan ‘leakage’

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Stuart | E + | Getty Images

Leaks are not just a problem for pipes.

Billions of dollars a year leave the US retirement system when investors withdraw money from their 401(k) plan accounts, potentially killing their chances to grow a suitable nest egg.

The issue mostly affects job brokers – especially those with small accounts – who often drain their accounts instead of taking them over. They lose their savings and future earnings on that money.

About 40% of workers who leave a job max out their 401(k) plans each year, according to the Employee Benefit Research Institute. Such “leakage” amounted to $92.4 billion in 2015, according to the agency’s most recent data.

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Research suggests that much of that loss is due to “touch” – it’s easier for people to take a check than go through the multi-step process of transferring their money to the new plan. their 401(k) or individual retirement account.

The 401(k) ecosystem would have nearly $2 trillion more over a 40-year period if employees didn’t cash out their accounts, EBRI estimated.

However, recent legislation — Secure 2.0 — and partnerships among some of the nation’s largest 401(k) administrators have come together to help reduce friction and existing leaks, experts said. .

The trend “has grown dramatically in the last few years,” said Craig Copeland, EBRI’s director of wealth benefits research. “If you can hold [the money] There without leakage, it will help more people get more money when they retire.”

85% of workers who cash out drain their 401(k)

US policy has many ways to try to keep money in the tax-favored retirement system.

For example, savers who withdraw money before the age of 59½ must pay a 10% tax penalty​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​frontside) on top of any income tax. There are also very few ways for workers to access 401(k) savings before retirement, such as loans or hardship withdrawals, which are also technical sources of leakage.

But job change is another entry point, and one that concerns policy makers: At that point, workers can choose a check (without tax and penalties), among other options.

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The average baby boomer changed jobs about 13 times from age 18 to 56, according to a US Labor Department survey of Americans born from 1957 to 1964. About half of the jobs were held before age 25.

One recent study found that 41.4% of workers cashed out some 401(k) savings when their job was terminated—and 85% of those people drained their entire balance.

“Did they need it? It’s hard to know for sure, but it’s not a logical conclusion that cashing out is a good or necessary response to leaving or losing a job,” said the authors – John Lynch, Yanwen Wang and Muxin Zhai – wrote about their research in Harvard Business Review.

It’s not all the staff’s fault

It’s not all the staff’s fault, though. By law, employers can cash out the small accounts held by former employees who leave their 401(k) accounts behind. They can do this without employees’ permission and send them a check.

Before 2001, employers could do so for accounts of $5,000 or less.

However, a law passed that year – the Economic Growth and Tax Relief Reconciliation Act – was among the early steps to keep more of that money in the retirement system.

If you can keep it [the money] then without leakage, it will help more people to have more money when they retire.

Craig Copeland

director of wealth benefits research at the Employee Benefits Research Institute

It prohibited employers from withdrawing balances between $1,000 and $5,000; instead, businesses that want those balances out of their company 401(k) must take the money to an IRA in the names of individual employees. Secure 2.0 raised that upper limit to $7,000 starting in 2024.

While that working IRA keeps more money in the retirement system, it’s an imperfect solution, experts said. For example, when rolled over, assets are typically held in cash-like investments such as money market funds, until investors decide to invest those assets differently. There, they earn very little interest while taxes go away on the balance.

Many investors also eventually get out of these IRAs, said Spencer Williams, founder of Retirement Clearinghouse, which manages these accounts.

Additionally, although employers notify employees of such IRA transfers, employees who do not take immediate action may forget about their accounts altogether.

Why a new 401(k) ‘exchange tool’ could help

In November 2023, six of the largest administrators of 401(k)-type plans – Alight Solutions, Empower, Fidelity Investments, Principal, TIAA and Vanguard Group – joined together on an “auto portable” campaign to stop put on a leak.

Basically, small balances – $7,000 or less – would automatically lead the owners to their new job, unless they choose otherwise. This way, employee savings would not be left out or rolled over to an IRA and could be forgotten.

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The concept uses the same hands-on approach as other popular 401(k) features such as automatic enrollment, taking advantage of employees’ inclination toward preferred inactivity.

Car portability is essentially a “very large exchange tool” within the 401(k) industry, said Williams, who is also president and CEO of the Mobility Services Network, the entity that facilitates the those affairs. (Retirement Clearing House manages the infrastructure.)

Caveat: One of the six participating providers must administer the employee’s 401(k) plan at their old and new employers in order to move to work, meaning that not all work is covered. The companies together administer 401(k)-type accounts for more than 60 million people, or about 63% of the market, Williams said. More are invited to join the coalition.

At 70% market coverage, automatic portability is expected to reconnect about 3 million people a year with 401(k) accounts they left behind after a job change, Williams said. The biggest benefits come to young workers, low earners, minorities and women, the groups most likely to pay cash and have the smallest balances, he said.

It’s not just employees who benefit: Administrators keep more money in the 401(k) ecosystem, possibly padding their profits.

Secure 2.0 also gave a legal blessing to the concept of car portability, providing a “safe harbor” for the automatic transfer of assets, experts said.

A ‘lost and found’ 401(k) is in the works

Raja Islam | Minute | Getty Images

That law also separately directed the U.S. Department of Labor to create a “lost and found” registry for old, forgotten retirement accounts by the end of 2024. The online public registry will help employees find plan benefits that may be missing. have and know who they should contact. them, according to a spokesperson from the Department of Labor.

“Millions of dollars of people’s earnings go unpaid every year because the plans have lost track of the employees and beneficiaries they owe money to,” said the spokesman. “This is a big step forward in tackling the problem.”

The Technology Innovation Fund, a government program, announced in November an investment of nearly $3.5 million by the Department of Labor to help build the database.

In the meantime, workers who suspect they may have left an account behind have a few options, according to a Labor spokesman:

  • Look at old records such as benefit statements or plan summaries to refresh your memory about benefits. You can also use the Department of Labor’s online search feature to find out if your employer or union has a retirement plan. Former colleagues may also be able to remind you of the company’s retirement plans, or if the company has since been acquired or changed its name.
  • Contact previous employers or unions to ask if you earned a retirement benefit. Contact persons may include the plan administrator, human resources, the employee benefits department, the company owner (if it is a small business) or a labor union.
  • Contact the Workers’ Compensation and Security Administration counselors for assistance at askebsa.dol.gov or by calling 1-866-444-3272.

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