Policy changes aim to reduce 401(k) plan leakage

Leaks are not just a pipe problem.

Billions of dollars a year are leaking out of the U.S. pension system when investors cash out their 401(k) plans, potentially hurting their chances of growing adequate savings.

This problem greatly affects those who change jobs, especially those with small accounts who often empty out their accounts instead of rolling them over. With this money they lose their savings and future income.

About 40% of workers who leave their jobs cash out their 401(k) plans each year. according to to the Employee Benefits Research Institute. According to the group’s latest data, such “leaks” amounted to $92.4 billion in 2015.

Research offers Much of this loss is due to “friction” – people find it easier to get a check than to go through the multi-step process of transferring their money into a new 401(k) plan or individual retirement account.

EBRI estimates that the 401(k) ecosystem would have received nearly $2 trillion more over 40 years if workers had not cashed out their accounts.

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

The movement has “really gained momentum over the last few years,” said Craig Copeland, director of wealth research at EBRI. “If you can keep [the money] without information leaking, it will help more people have more money when they retire.”

US policy has many mechanisms to keep money in a tax-advantaged retirement system.

For example, savers who withdraw money before age 59½ typically must pay a 10% tax penalty in addition to any income taxes. Workers also have several ways to access 401(k) savings before retirement, such as loans or hardship withdrawals, which are also technically sources of leakage.

But changing jobs is another entry point that worries policymakers: At that point, workers can choose a check (less taxes and penalties), among other options.

More from the “Personal Finance” section:
How to save for retirement at 50
What You Need to Know About Aging in Place in Retirement
States are trying to close the pension savings gap

According to the U.S. Department of Labor, the average baby boomer changed jobs approximately 13 times between the ages of 18 and 56. analysis Americans born between 1957 and 1964. About half of the jobs were occupied by people under 25 years of age.

One recent training found that 41.4% of employees cash out their 401(k) savings when they leave, and 85% of them empty their entire balance.

“Did they have to do this? It’s hard to say for sure, but it’s by no means a logical conclusion that cashing out is a good or necessary response to quitting or losing a job,” by John Lynch, Yanwen Wang and Muxin Zhai. — wrote of his research in the Harvard Business Review.

However, not everything is the workers’ fault. By law, employers can cash out small account balances of former employees who left their 401(k) accounts. They can do this without the employees’ consent and send them a check.

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

But legislation passed that year—the Economic Growth and Tax Relief Act—was one of the first steps to keep more of those funds in the pension system.

This prohibited employers from cashing balances between $1,000 and $5,000; instead, businesses that want to withdraw those balances from their company 401(k) must roll over the funds into IRAs in the names of the eligible employees. Secure 2.0 raised this cap to $7,000 starting in 2024.

While this IRA workaround allows you to keep more money in your retirement system, it’s an imperfect solution, experts say. For example, in a rollover, assets are typically held in cash-like investments, such as money market funds, until investors decide to invest the assets differently. There, they earn relatively little interest while fees wipe out the balance.

Many investors also end up cashing out these IRAs, says Spencer Williams, founder of Retirement Clearinghouse, which manages such accounts.

Additionally, although employers notify employees of these IRA rollovers, employees who do not take immediate action may forget about their accounts entirely.

In November 2023, the six largest 401(k) plan administrators—Alight Solutions, Empower, Fidelity Investments, Principal, TIAA, and Vanguard Group— united by the “automotive” initiative to further prevent leaks.

Simply put, small balances—$7,000 or less—will automatically follow their owners to new jobs unless they choose otherwise. This way, workers’ remaining savings won’t be cashed out or rolled into an IRA and potentially forgotten.

The concept takes the same hands-off approach as other currently popular 401(k) features, such as auto-enrollment, to leverage workers’ propensity for inactivity to their advantage.

Car portability is essentially “a very large exchange mechanism” in the 401(k) industry, said Williams, who is also president and CEO of Portability Services Network, an organization that facilitates these transactions. (The Pension Settlement Center manages the infrastructure.)

A word of caution: To make a job transfer, one of the six participating providers must administer the employee’s 401(k) plan at both their old and new employer, meaning not all employees will be covered. The companies collectively manage 401(k)-type accounts and serve more than 60 million people, or about 63% of the market, Williams said. We invite others to join the consortium.

With 70% market penetration, car portability is expected to reconnect about 3 million people a year to the 401(k) accounts they left behind after changing jobs, Williams said. The biggest benefits go to young workers, low-income people, minorities and women, groups that are most likely to cash out and have the smallest balances, he said.

It’s not just workers who benefit: Administrators keep more money in the 401(k) ecosystem, likely increasing their profits.

Secure 2.0 also gave legal blessing auto portability A concept that provides a “safe harbor” for automatic transfer of assets, experts say.

The law also directed the U.S. Department of Labor to create a “lost and found” for old, forgotten retirement accounts by the end of 2024. An online public registry will help workers find plan benefits they may be entitled to and determine who to contact to gain access. them, according to a Labor Department spokesman.

“Millions of dollars that people earn go unpaid each year because plans have overlooked workers and their beneficiaries to whom they owe money,” the spokesman said. “This is a significant step forward in solving the problem.”

Technology Modernization Fund, state program, in November announced nearly $3.5 million investment with the Department of Labor to create the database.

In the meantime, according to a Labor Party spokesman, workers who suspect they may have abandoned the account have several options to get it back:

• Review old records, such as benefit statements or plan summaries, to refresh your memory of benefits. You can also use the services of the Department of Labor. online search function to find out if your former employer or union has a pension plan. Former colleagues will also be able to remind you about the company’s pension plans or whether the company has since been acquired or changed its name.

• Contact former employers or unions to find out if you received retirement benefits. Contacts may include the plan administrator, human resources, employee benefits department, company owner (if a small business), or union.

• Contact Employee Benefits Security Administration Consultants at: Askebsa.dol.gov or by calling 1-866-444-3272.

Don’t miss these stories from CNBC PRO: