Despite great advances in our nation’s retirement system over the past several decades, too many Americans remain under-saved for a financially secure retirement.
Much of this problem is linked to the “leakage” of retirement assets, the vast majority of which comes from plan participants – the employees of companies that sponsor 401(k) savings plans – prematurely cashing out of 401(k) accounts. According to the Employee Benefit Research Institute (EBRI), $92.4 billion is prematurely cashed out of the U.S. retirement system every year.
The primary reason for these cash-outs has been the lack of a seamless process for participants to take their 401(k) account balances with them when they switch jobs. Unfortunately, the process of moving a 401(k) balance from an account in their prior employer’s plan and consolidating it into an active account in their new or current employer’s plan is very expensive and time-consuming.
This is why the easiest options for many job-changing participants have been to either cash out their 401(k)s after leaving an employer or simply abandon their account in their former employers’ plan.
The combination of this difficulty and the increasing mobility of the American workforce — EBRI data indicates that the average American will change jobs 9.9 times during a 45-year working period — has led to an uptick in small, stranded accounts in 401(k) plans.
An Opportunity For Advisors
A 2023 report by Capitalize stated that $1.65 trillion was sitting in forgotten or lost 401(k) accounts. This creates an opportunity for financial advisors to demonstrate significant value and strengthen their client retention.
This creates an opportunity for financial advisors to demonstrate significant value and strengthen their client retention.
Cash-outs are disastrous. A hypothetical 30-year-old who cashes out a 401(k) account with $7,000 today will obtain a net sum of just $4,900, following taxes and penalties — but if the same participant chose to keep that $7,000 balance invested in the retirement system, they would see the savings grow to more than $74,000 by age 65, if we assume 7% annual growth.
Furthermore, leaving behind a 401(k) account with less than $7,000 puts the savings that an employee has accrued at risk of being automatically rolled out of a previous employer’s plan into a safe-harbor IRA — typically a money market account with high fees that may deplete savings over time.
Cash-outs and abandoned accounts don’t only hurt individual retirement-savers, they also have a negative impact on 401(k) plans and their sponsors as well. They tend to decrease important plan metrics like average account balance, and can also potentially open sponsors to fiduciary liability by participants years down the line complaining that they weren’t given more guidance to avoid cashing out (or that they didn’t know their abandoned accounts were automatically rolled into safe-harbor IRAs).
The Solution That Can Help Plan-Sponsor And Individual-Saver Clients
Financial advisors can step in to provide value by encouraging their 401(k) plan clients to adopt technology solutions that enable auto portability — the automatic, routine and standardized movement of a plan participant’s account with under $7,000 in a prior-employer’s plan into an active account in their current employer’s plan, as enabled in the SECURE 2.0 Act.
Advisors see the financials of their clients’ 401(k) plans, and what leakage does to them. They can build out their books of business by encouraging those clients to pursue auto portability.
All the players in the retirement system that participate in auto portability agree to both send and receive account balances. Contractually, they must agree to rules of reciprocity that require plans and recordkeepers to accept auto portability roll-in contributions in the same range as the accounts that they are forcing out via a mandatory distribution. For example, a plan that would only like to send terminated participant balances in the amount of less than $1,000 through the auto portability network will be limited on the roll-in side to only accounts with less than $1,000.
Auto portability’s “rules” create two-way flows for participants’ savings. Accounts that leave are replaced by new hires’ accounts that are rolled into plans. In contrast, cash-out leakage and automatic rollovers without the auto portability capability create one-way flows — out of plans. Auto portability enables more assets to flow into the plans sponsored by advisors’ 401(k) clients through automated roll-in contributions.
Auto portability enables more assets to flow into the plans sponsored by advisors’ 401(k) clients through automated roll-in contributions.
But until their business clients sign up for auto portability, those plans can’t receive those inflows. Advisors can play a vital role in turning the losses of cash-out leakage into wins for their clients — and at the same time, help those clients increase their plans’ key metrics. In addition, advisors can assist individual retirement-saving clients by encouraging them to take advantage of auto portability to move and consolidate their 401(k) savings when they change jobs.
According to our research, an estimated $1.6 trillion in additional savings would be preserved in the U.S. retirement system if auto portability were to be adopted by sponsors and recordkeepers nationwide over a 40-year period. That sum would include $744 billion more in retirement savings for 98 million minorities.
Spencer Williams is CEO of Portability Services Network, a utility for facilitating the adoption of auto portability, and Retirement Clearinghouse, a portability services provider.
