I recently had the opportunity to speak with Ted Benna, the co-creator of the 401(k), to get his perspective on the future of DC plans and how participants can maximize their retirement readiness. By definition, Ted has the longest ranging perspective on the evolution of the 401(k) plan, as well as a unique view of the U.S. retirement system and where it needs to go from here. Two major themes emerged from our discussion on how to improve the workplace retirement system:
• making account consolidation simple and widely available to participants; and
• the importance for sponsors to de-risk their 401(k) plans.
Portability a Problem
Originally launched as a supplemental retirement savings vehicle when Social Security benefits were a certainty, defined benefit plans were abundant and lifetime employment was the norm, the modern-day 401(k) has taken center stage as the primary retirement savings vehicles for most Americans.
Benna gives high marks for the effectiveness of the 401(k) infrastructure in bringing money into plans to help support the challenges of retirement savings accumulation. But while legislation allowing features such as auto-enrollment and payroll deductions have been widely adopted by sponsors, the infrastructure and processes enabling portability of assets have not sufficiently evolved to accommodate the rapid growth of the number of participants and the multiple accounts of a highly mobile workforce.
Consider what the research suggests:
• As many as 20% of the 70 million existing participants — or 14 million people — have at least one account with a previous employer. (Boston Research Group).
• The average American changes jobs eight times in a working lifetime (EBRI).
• The likelihood is high that people will have several accounts with previous employers.
Consolidation is Key
“In talking with participants with multiple retirement accounts (DC, IRA and personal savings) over the years, I have discovered that most of them typically have no idea how or where their money is invested,” says Benna. “Having retirement savings spread among numerous accounts reduces the prospects for a successful retirement. It is highly unlikely that employees who fit this profile are working toward a well-defined goal. How can they be, if they have so little knowledge about where their various accounts are held and how they are invested?”
But consolidating accounts is not for the faint of heart. Even the “father of the 401(k)” avoided the consolidation process until recently. “Despite the significant advantages to consolidating my retirement accounts under one roof, I put off this project until I was willing to endure the time and frustration that I knew would be involved,” he said. “It was as difficult as I expected but I endured until my mission was accomplished.”
Interestingly, BRG’s research shows that the easiest transaction (i.e., requiring almost no assistance) to make when terminating a job is the least desirable — the cashout. The most difficult transaction, yet the most desirable, is rolling balances into another DC plan. Essentially, processes and procedures are working against retirement readiness.
But the payoff is clear. Benna points out that consolidating accounts helps improve retirement preparedness by:
• tracking the total amount of retirement savings
• simplifying investment decision-making and management
• enabling an organized distribution strategy
• simplifying matters for beneficiaries
Benna urges plan sponsors and service providers to support the efforts being made to break down the administrative barriers hindering consolidation. “Helping employees successfully retire is a national concern. Shifting the focus from lump sum cashouts to retirement account retention via account consolidation, especially when job changes occur, can be key to retiring successfully. Keeping more money in retirement savings will result in trillions of dollars of additional retirement savings in the coming years.”
De-Risking DC Plans
Clearly, lack of consolidation is a serious drag on participants’ retirement readiness, but as Benna points out, it also creates a great deal of risk for the plan sponsor. Regulations state that DC plan sponsors must provide an equal amount of support to former and current employees. “It’s very difficult — if not downright impossible — to provide the same level of support to former employees as active employees. This hard reality increases the potential for inactive employees to yell ‘foul!’ and as a result, time management decisions must be made,” he argues. “Former employees are simply not likely to receive a lot of attention. Why not remove the risk and reduce the time demands by embracing retirement account consolidation, and getting former employee accounts off your books?”
Importantly, it is a risk that many plan sponsors may not realize they face. Research conducted by BRG indicates that:
• Nearly a third of plan sponsors don’t know the percentage of their plan participants who no longer work for the company. Of those who could provide an answer, the number of participants working elsewhere is 15%. Applying this percentage to 70 million participants translates to 10 million accounts held by ex-employees.
• Two-thirds of 401(k) plan sponsors either prefer that accounts of ex-employees with more than $5,000 stay in the plan (10%) or don’t have any preference whether the accounts stay or leave (58%).
These statistics would probably be much different if plan sponsors understood the risk of having ex-employees on their DC books.
The Path Ahead
One final recommendation from Benna: “Retirement savings leakage can be even further reduced by changing the law to require employees to keep their retirement savings in the game when they change jobs, or when plans are terminated. This could be accomplished via an electronic transfer into the next employer’s plan, or into an IRA.”
As we look back over the past 40 years, we can clearly see the evolution of the DC system, driven by a lot of smart people sincerely dedicating to improving retirement readiness. But the job is only half done. Millions of American workers change jobs each year. As Benna states, account consolidation should be widely available to all participants. Millions of DC accounts are stranded, dampening retirement readiness and creating fiduciary risks in the process.
