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You Can Take it With You

These days there’s little controversy about the wisdom of using behavioral finance to help workers start saving – but what about when they change jobs?

While “leakage” – loosely defined as a pre-retirement withdrawal of retirement savings – is widely disparaged as undermining retirement security, research[1. A 2014 analysis by EBRI found that approximately two-thirds of the impact of diminished retirement savings due to leakage was associated with the cashouts that sometimes occur at job change. Others have pointed out that 401(k) loans, which sometimes are criticized as a significant source of retirement savings leakage, actually account for the smallest amount of pre-retirement savings loss.] by the non-partisan Employee Benefit Research Institute (EBRI) suggests that the “real” culprit between participant loans, hardship withdrawals and distributions at job change is the latter (though some of the latter comes from participant loans that are “deemed” distributions at job change). It also winds up being the most difficult to “cure” via plan design, which arguably can restrict/limit loans and hardships.

The reality is that, even in the most amicable of partings, workers have traditionally lacked the particulars to facilitate a rollover to either an IRA or a subsequent employer’s retirement plan (assuming those rollovers were permitted) – and thus, the easiest thing to do for most has been to simply request that their vested account balance be paid in cash.

Over the years, a number of changes have been made to discourage this “leakage” of retirement savings at job change: Legal thresholds for mandatory distributions have been set, and a requirement established that distributions between $1,000 and $5,000 on which instructions are not received either be rolled over into an IRA or left in the plan. You could even argue that the requirement that a 20% tax withholding would be applied to an eligible rollover distribution – unless the recipient elected to have the distribution paid in a direct rollover to an eligible retirement plan, including an IRA – serves to at least give a participant pause when it comes to cashing out. All these have doubtless served to at least give pause to that individual distribution “calculus” at job change. Indeed, for those with larger accounts, it is now arguably easier to leave your money with an old employer than to roll it over into some other account, though it surely makes keeping track of, and managing those “old” accounts more complicated.

Nor is this a small problem – Retirement Clearinghouse CEO Spencer Williams explained at a recent Financial Services Roundtable event that 14.8 million 401(k) plan participants change jobs every year. That’s approximately the total number of participants recordkept by Fidelity.

Enter “auto-portability” – an approach that would “automatically” roll distributions from your previous employers’ plans into your new employer’s plan. How much difference could it make? EBRI Research Director Jack VanDerhei applied some auto-portability assumptions to several different scenarios. For individuals aged 25-34 in the lowest income quartile, assuming auto-portability for those with balances over $5,000 (indexed for inflation), it could mean nearly a 25% increase in their aggregate balances at age 65. With the same assumptions, but broadened to include auto-portability for all balances (not just those over $5,000), the increase was just over 35%!

All told, over a 10-year time horizon, partial auto-portability would result in an additional $256 billion in retirement savings, and $1.5 trillion over a 40-year period. For full auto-portability, VanDerhei’s model projects $472 billion and $1.9 trillion, respectively.

There are issues with this approach, of course – things ranging from the willingness of the new employer to take on those balances (that employer might not have a plan, and there are some legal considerations even if they do) to potential mismatches in investment menus – not to mention some potential implications with the new fiduciary regulation’s view on rollovers. Still, it’s an approach that could remedy much of the impact of this most damaging kind of leakage: among job changers with a balance less than $5,000.

They say you can’t take it with you – but with a solution like auto-portability, perhaps more would.