Auto Portability may be making a grand entrance. A high-profile retirement plan fee lawsuit brought to light some confusion over the definition of a “fiduciary”. The role of the fiduciary may soon be rewritten by the court system! The same goes for the fiduciary roles and responsibilities – and exactly what that may include. For those unfamiliar, the suit, Hughes v. Northwestern University, went all the way to the Supreme Court. Although the ruling pertained specifically to investment options with high fees, the precedent could ultimately put fiduciaries at risk for other types of breaches. It could also impact decisions that result in excessive cash-out leakage for terminated participants.
That’s the perspective of Spencer Williams, President and CEO of portability solutions provider Retirement Clearinghouse, who recently penned an article for BenefitsPro. Mr. Williams noted that these risks can be avoided if plan sponsors proactively adopt solutions that allow participants to easily take their retirement savings with them when they leave their employer. This opens the door for auto portability.
The Supreme Court ruling in Hughes v. Northwestern “mandates that the ability of participants to choose from a selection of inexpensive and higher-cost investment options in defined contribution retirement plans. At question is, preventing lawsuits claiming that plan sponsors are in breach of the Employee Retirement Income Security Act’s duty of prudence for fiduciaries.” per Mr. Williams. The fiduciaries in question are plan sponsors who manage workplace retirement plans such as 401(k)s.
However, Mr. Williams also pointed out that the Supreme Court ruling muddies the definition of fiduciary. This further complicates the matter. However, he wrote that, “This is why, in addition to the oversight of investment options in their plans, sponsors should assume they could be held accountable for decisions they make regarding the disposition of accounts from terminated participants.”
The Economic Growth and Tax Relief Reconciliation Act of 2001 provided plan sponsors the ability to automatically cash out terminated participant accounts with balances less than $1,000 and automatically roll terminated accounts with less than $5,000 to safe-harbor IRAs. However, according to Mr. Williams, this can be harmful to participants’ retirement outcomes in the long run because:
- Small accounts with under $1,000 would grow in balance size if they remained invested in the U.S. retirement system.
- If the checks for less than $1,000 are sent to out-of-date mailing addresses in the files of plan recordkeepers, then participants wouldn’t receive their savings, and wouldn’t know they had been cashed out.
- Safe-harbor IRAs can gradually diminish retirement savings in accounts automatically rolled over to them.
- The only default investment choices allowed in safe-harbor IRAs are principal-protected products (money market funds). These products have yielded extremely low returns given where interest rates have hovered since the financial crisis of 2008.
- Safe-harbor IRAs can also apply high fees, with some charging as much as $50 or more in annual administration, according to publicly available product information. This is well beyond two times the interest earned on a $1,600 account balance, on average, at a yield of 1%.
Participants who prematurely cash out their savings also do irrevocable damage to their income prospects in retirement, according to the Employee Benefit Research Institute (EBRI).
As cited by Mr. Williams in BenefitsPro, $92 billion in savings is cashed out in the U.S. retirement system every year. In addition, before Covid-19, EBRI estimated that nearly 15 million participants switched jobs every year. And data from the largest recordkeepers indicate that nearly one-third (31%) would cash out their retirement accounts upon joining another employer.
It’s no wonder – rolling assets from one employer-sponsored retirement plan to another is not an easy process. Auto portability was designed to help simplify the process of moving retirement savings and reducing destructive cash-outs. Auto portability can also help mitigate fiduciary risk by eliminating mandatory distributions, according to Mr. Williams.
Auto portability allows participants with retirement account balances of less than $5,000 to automatically move their savings from a former employer’s plan to their new employer’s plan. If auto portability is widely adopted over 40 years, EBRI estimates that up to $2 trillion in additional savings (in today’s dollars), could be salvaged in America’s retirement system. That, and the potential positive retirement outcomes, appear to make auto portability solutions worthy of sponsors’ consideration.
