Labor Department Clears Path for Automatic 401(k) Transfers

Companies could start automatically transferring small retirement accounts belonging to employees who change jobs to the 401(k) plans of their new employers, according to new guidance from regulators.

Source: WSJ - Anne Tergesen | Published on November 13, 2018

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The move is the latest effort to reduce the premature flow of money out of 401(k)-style plans. A pair of recent Labor Department actions would give Retirement Clearinghouse LLC of Charlotte, N.C. a green light to automatically transfer small balances of $5000 or less to a new employer’s 401(k) plan, provided the employee doesn’t opt out. For balances above $5000, the employee’s permission is generally required before money is transferred. The Labor Department may ultimately give other companies permission to enter the market, provided they agree to the conditions it set for Retirement Clearinghouse.

Such automatic transfers have the potential to sharply reduce the millions of employees who raid their 401(k)s when they switch jobs, the biggest source of what the industry calls leakage, analysts said.

“You’re talking about potentially billions of dollars staying in the retirement system that would otherwise be lost,” said Aron Szapiro, director of policy research at Morningstar, Inc.

In a news release, the Labor Department cited the possibility that such automatic transfers would “eliminate duplicative fees for small retirement savings accounts and reduce leakage of retirement savings from the tax-deferred retirement savings system.”

It is unclear whether employers and companies that serve as 401(k) record-keepers will adopt the new service on a widespread basis, industry participants said. For example, because of privacy concerns, some may balk at the prospect of sharing information about 401(k) savers with the company facilitating the transfers.

On average, about 30% of people leaving jobs elect to cash out their 401(k) accounts and pay taxes—and often penalties—rather than leave the money or transfer it to another tax-advantaged retirement plan, according to industry research. As many as 80% of people leaving jobs with less than $5,000 in their accounts eventually cash out.

Tapping retirement funds early threatens to reduce the wealth in U.S. retirement accounts by about 25% when the lost annual savings are compounded over 30 years, according to an analysis by economists at Boston College’s Center for Retirement Research.

Under current law, employers can mail a check to former employees with balances of $1000 or less, making it easier for employees to cash out their accounts. For those with balances between $1000 and $5000, employers must either transfer those funds to an individual retirement account or keep them in the plan, unless the employee directs otherwise.

Because of Labor Department regulations, the IRAs are generally invested in either a money market or certificate of deposit, which offer low returns. Some participants even lose track of such accounts.

Mark Iwry, who oversaw retirement policy in the U.S. Treasury Department during the Clinton and Obama administrations, said automatic transfers “should be a major step forward in reducing leakage.”

Retirement Clearinghouse Chief Executive Spencer Williams said his company requested the Labor Department advisory opinion because plan sponsors and 401(k) record-keepers wanted greater clarity about who has fiduciary liability for the service. The Labor Department clarified that Retirement Clearinghouse is the fiduciary for the transaction, he said.

Separate guidance from the agency would shield the firm from a provision of the Employee Retirement Income Security Act of 1974 prohibiting fiduciaries from self-dealing, including earning fees as a result of their recommendations. The Labor Department has asked the public to submit comments before it completes the proposed exemption.

The company plans to charge a maximum one-time fee of $59 for each transfer. For accounts with $590 or less, the charge will be 10% of the balance, and the service is free for accounts with $50 or less, said Mr. Williams.

Retirement Clearinghouse, which has been developing the service for years, is building a system to share data on 401(k) participants with record-keepers to find a departing employee’s new plan and facilitate the transfer. One client is currently using the system, said Mr. Williams, who predicts volume will increase over the next year.

Currently, almost 15 million Americans with 401(k) accounts change jobs annually, said Mr. Williams. One-third, or about 5 million, have balances of $5000 or less, and roughly 80% of those people cash out their accounts within seven years of leaving a job, he said.

Automatically transferring all these small 401(k) accounts would save participants an additional $1.5 trillion, in 2017 dollars, over 40 years, according to the nonprofit Employee Benefit Research Institute. Currently, 401(k)-style accounts hold almost $8 trillion, according to the Investment Company Institute, a trade group for mutual funds.

Some analysts said automatic transfers are likely to appeal to 401(k) record-keepers, many of whom are eager to get rid of small accounts that can cost more to administer than they earn in revenues.