Plan sponsors intuitively know that an explosion of small-balance 401(k) accounts held by terminated participants can create problems.
Unfortunately, few sponsors are clear on the factors that give rise to small accounts, and fewer still understand how they can utilize consolidation programs to solve the problem.
Here’s a high-level framework to help plan sponsors understand and address the small account problem, applying proven solutions that promote account consolidation.
Key causes of small accounts
Individually, the factors identified below can drive a proliferation of small accounts:
- Mobile workforce: The propensity of the American 401(k) participant to frequently change jobs – currently estimated to occur almost 10 times in an average career.
- Business growth: Growth, whether by diversification, by acquisition or simply organic growth will increase the base number of participants, and tend to increase the incidence of small accounts.
- Employee turnover: Certain industries traditionally experience high levels of employee turnover (ex. – retail, health care, food service). This turnover directly drives higher percentages of separated participants in plan, many of whom will leave small balances behind.
- Auto-enrollment: Plans that utilize an auto-enrollment feature will enjoy higher participation levels, but will likely also experience unintended consequences in the form of a large number of small-balance accounts.
When combined, the resulting small accounts can create big problems for plan sponsors.
Problems posed by small accounts
Here’s a short list of some of the headaches that plan sponsors face when small accounts begin to grow:
1. Reduced retirement readiness metrics
2. Higher plan costs
- Lower average balances = higher record keeping fees
3. Administrative burdens
- Locating missing participants
- Resolving uncashed checks
- Handling returned mail
4. Increased fiduciary risk
- Missed mailings (statements, SPDs, etc.)
- Unnecessary & excessively high participant cashouts (up to 60% for participants with less than $5,000)
- Risk of DOL or IRS audits with respect to missing participants, particularly those who are due benefits
The solution is simple: Consolidate the balances. Implementing programs that deliver true portability for plan participants solves the small account problem for plan sponsors.
The best consolidation programs are strategic solutions that work directly to reduce the number of small accounts. Strategic consolidation programs include the following:
1. An automatic rollover (ARO) program to handle mandatory distributions for separated participants with less than $5,000.
It’s important to point out that not just any ARO program will deliver true portability. Plan sponsors should ensure that their ARO provider has a proven record of reducing cashouts and consolidating these small balance accounts back into the 401(k) system.
In short, an ARO provider should conform to the principles of auto-portability.
2. A facilitated roll-in program for existing plan participants (all balances).
New and existing plan participants can take full advantage of your plan by consolidating their former retirement savings accounts into plan.
But don’t force your participants into DIY roll-ins. Instead, choose an independent, facilitated roll-in service provider to make the process easy. Facilitated roll-in service fees are considered permissible plan expenses.
3. A roll-out program for separated participants with greater than $5,000.
Your plan may have large numbers of separated participants who have “stranded” their savings in your plan, while having moved on to other positions with new retirement savings plans.
Unbiased roll-out programs will conduct outreach to all separated participants with balances over $5,000, advise participants of their options, discourage cashouts and, where indicated, assist participants in consolidating their retirement savings into a current, active plan or IRA.
Roll-out programs can reduce stranded accounts, cashouts and missing participants, while avoiding unnecessary fiduciary risk.
“Tactical” solutions address the secondary problems caused by small accounts, but do not address their underlying causes. Tactical solutions include the following features:
1. Address location services for missing participants.
Our workforce not only changes jobs frequently, but is geographically mobile. Industry sources estimate that anywhere from 3-6% of participants are missing, with forgotten accounts and outdated address information on file. Missing participants can result in returned mail, un-cashed distributions and unpaid benefits, dramatically increasing your fiduciary risk. With high numbers of separated participants comes the risk of missing participants.
Your provider’s missing participant search service should be effective, flexible and affordable, allowing you to choose the appropriate level of service, but pay only for the level of service required.
2. Uncashed check services.
An uncashed distribution check service can resolve returned checks by creating an after-tax rollover IRA. The service should then conduct periodic searches to reunite your former participant (or their beneficiaries) with their funds.
Plan sponsors who not only understand the small account problem, but also implement effective consolidation solutions will promote increased retirement readiness and lifetime plan participation, benefiting their plan, as well as its participants.