(Forbes) It should come as no surprise that an economist can find something to worry about in an otherwise pretty good situation.
The current labor market is no exception. More and more workers are taking advantage of the improving labor market by changing jobs. But, job hopping can pose challenges for workers managing their 401(k) savings as they leave their employer, possibly hurting their retirement security down the line.
They could cash out their money now, which would cost in fees and taxes and also lower retirement savings. Other options preserve retirement savings, but are more complicated and could potentially cost substantial fees. Employees with small account balances – younger, lower-income employees – face the biggest risks to their retirement finances when leaving a job where they had a 401(k) plan.
The Department of Labor’s Employee Benefits Security Administration (EBSA) is now considering giving one company – Retirement Clearinghouse (RCH) -- an exemption from existing law. The goal supposedly is to make it easier for RCH to help savers with small account balances to move their money from the old employer’s retirement plan to a new employer’s plan.
A growing number of people are switching jobs as new and presumably better opportunities become more readily available. The Bureau of Labor Statistics reports that the number of workers quitting their jobs has steadily grown since September 2009 and is now even higher than before the Great Recession of 2007 to 2009. In September 2018, 3.6 million workers quit their jobs.
What does greater job churn mean for U.S. workers’ retirement prospects? On the one hand, it is probably a positive indicator that workers are moving up to jobs with better pay, hours and/or benefits. But the impact on retirement security also depends a lot on what workers do with the funds in their 401(k) when they switch jobs. They could cash the money out, roll it over to an Individual Retirement Account (IRA) or consolidate with a new employer’s 401(k) plan. Their choices can have high-stakes for their retirement income security.
Cashing out of your 401(k) is arguably the worst option for future retirement security .
Yet, cash-outs are the default forced on many employees with low account balances (under $1,000). The law allows previous employers to force those, who have left and who had small balances, out of the 401(k) plan. This disproportionately impacts younger, lower paid, and shorter-tenured workers.
Unless workers quickly deposit these forced cash-outs into an IRA, they will face tax penalties and the funds likely end up being spent on current consumption, rather than put away for future needs. Not surprising, cash outs are a big source of retirement savings leakage.
The problem of small account balances that will be cashed out has likely grown over time. Since the passage of the Pension Protection Act in 2006, a growing number of employers have automatically enrolled their employees in 401(k)s, but many employees may not even know that they have a 401(k) plan because they didn't actively decide to sign up. On the one hand, this is good news. It means that automatic enrollment works as intended and people actually save for retirement. But on the other hand, people may forget that they actually have retirement savings, when they switch jobs. Without employees actively deciding to take the money with them, employers will cash out small balances. The benefits of automatic enrollment up front could easily be undone by the lack of automatic options to transfer to a new employer's 401(k) plan.
Rolling over funds to an IRA is a better option for small accounts, but often involves paying higher fees, which quickly eat away at small balances. When the Government Accountability Office looked at the problem of fees in forced rollovers into IRAs, they found that fees outpaced investment returns in most of the accounts they analyzed. Workers’ balances simply dwindled to nothing over time. Worse, workers with frequent job changes can end up with multiple IRA accounts, paying fees multiple times that eat away even faster at hard-earned savings. Yet, another source of leakage.
For most people, the ideal is to consolidate one’s retirement accounts into a single, low fee account that is easy to keep track of. In other words, find a way to plug the leaks. RCH thinks it has a solution to make account consolidation automatic that relies on the cooperation of the large retirement plan recordkeepers – companies that keep track of employees with a 401(k) plan for employers. Using a technology that locates, matches, and transfers assets, RCH queries cooperating recordkeepers’ systems to determine if someone holding a forced roll-over IRA has subsequently landed in a new job with a 401(k) being administered by that same recordkeeper. When it finds a match, the funds are rolled into the new 401(k) plan. The good news is the approach appears successful in reducing leakage and increasing workers’ retirement account balances. The bad news - regulators have determined that the company’s approach could run afoul of provisions in federal pension law.
EBSA is considering granting the company an exemption from pension law to make it easier to coordinate between the various parties involved and has invited the public to weigh in by December 22. EBSA states it welcomes other innovations to encourage portability and reduce leakage. Where the agency lands on these questions may have a large impact on the financial future of a workforce that is increasingly mobile.