Auto-Portability: Default IRA Boon or Bust?
In my 50 years in the business world, it has always fascinated me how quickly pension industry professionals can incorporate changes brought about by new laws or regulations.
For example, I recently read an article in the Retirement Income Journal that discusses “auto-portability,” a fancy term to describe the DOL FAB 2014-01 that deals with Default/Missing Participant IRA’s. Penned by Kerry Pechter, an editor for the RIJ, the article No Retirement Account Left Behind is well written but seems determined to make a simple process far more complex than it needs to be.
The article describes auto-portability as a technology involving “electronic records matching,” which is the same identification and verification process used during credit/debit card transactions. However, in order for this technology to work with auto-portability, it requires getting all industry record keepers on board, a task that Pechter acknowledges would be no slam-dunk. So right off the bat we’re looking at a major hurdle to clear.
Auto-portability would also require the DOL’s blessing because employees must be auto-enrolled from the time they first enter an employer’s plan. As the article states, Retirement Clearinghouse (RCH), which specializes in portability services for plan sponsors, proposes to run a program that will enable this to happen at a per-participant fee of $59 per account. This fee will pass through their system to the new employer plan, but will add an additional cost that currently doesn’t exist.
Stopping the Leakage
The idea behind this proposed high-tech program is to fix the damage done by leakage – money left unclaimed by participants or their decision to take a lump sum distribution versus rolling over their funds into a new account. The article argues that if you were designing an employee-sponsored retirement savings system from scratch, you would probably build in a method that allows people to easily transfer money from their previous plan(s) to their new one when they change jobs.
A good idea, except the ability to do this has been around since the enactment of ERISA, although not as seamless as it needs to be. Trust-to-trust transfers are quite common, especially when employees leave one employer and go to another. The article also states that IRA rollovers were not created to stop the leakage problem, and there is some truth in that. Rather, they were primarily designed to serve as a placeholder for participants who didn’t want to lose their tax-deferred status while seeking new employment, and for retired participants who wanted more control over their accounts. IRA rollovers also help in situations where plan sponsors want to terminate their plan but some participants can’t be found.
Unfortunately, the Default IRA was designed with a serious flaw – the $5,000 threshold – that, in my opinion, minimizes its effectiveness. Setting the threshold at $10,000 would allow for a more realistic account balance and would help plan sponsors remove more of those types of accounts from their plans. I also disagree with the idea that when participants have $1,000 or less in the plan, sponsors should just write a check and withhold the taxes. This approach has created more headaches by leaving a plethora of uncashed checks that allow institutions to retain the float on those checks.
Not As Simple As it Seems
RCH describes their program in terms of “push rather than pull” technology. In other words, their process begins when the employee’s account gets pushed out of the old plan, which often occurs long after the former participant has changed jobs. Assuming the employee has elected to keep his funds in the old plan, the plan sponsor then sends the account balance to the institution selected to administer the auto-rollover, and RHC tries to match the participant with the new plan.
However, attempting to transfer the funds to a new employer, you must first find the participant and turn their funds over to them. This also assumes that the new employer will accept a rollover into their plan. Furthermore, several additional steps must be taken before the new employer will accept the plan. For example, they will want evidence the money has come out of a qualified plan. They may ask for a copy of the former employer’s summary plan description. And if the money is a Roth account coming from a qualified plan, additional requirements must be met.
Once you locate the participant, clear the OFAC (Office of Foreign Assets Control) hurdle, and properly document the claimant’s identity, the former participant must complete a benefit election form detailing how the Auto Rollover custodian should handle their money. If they elect to roll over their funds to a new employer, proper instructions also need to be given as to plan description, account number, and how the funds are to be pushed to the new employer plan. As a result, the plan sponsor must take on an added role in RHC’s process they didn’t have to do before, further complicating what should be a fairly simple process.
Once they receive the funds, RCH would use its electronic record matching process to send a search request to record keepers throughout the country. This would involve using the participant’s social security number to ask record keepers if they have a participant with that number in any of their 401(K) plans. If a match comes up, the process of attempting to transfer those funds into that plan begins.
A Hurdle Too Big To Clear
Auto-portability is a clever concept. But today’s record keepers are overwhelmed by regulations and the complexity of administering qualified plans, especially 401(k) plans, to allow for such a search. Also, what’s to prevent misinformed or fraudulent efforts, especially on account balances under $5,000, that many plan sponsors would prefer to get off their books? Furthermore, one has to wonder by what authority is either side entitled to carry on such a search, and whether there might be some fiduciary concerns – such as the sharing of confidential social security numbers.
And what if the participant is enrolled in a non-401(k) plan where individualized records are recorded differently, or a 401(k) plan that does not offer investment choices to its participants? In my opinion there seems to be too many unanswered questions with RHC’s approach. When dealing with financial institutions, all kinds of security issues can arise when trying to electronically transfer funds in and out of an account.
So while I applaud the creative thinking that has gone into this concept, my years of experience administering missing participant accounts suggest that the complexity and tremendous buy-in required by financial institutions and plan sponsors might be too big a hurdle to overcome. The entire industry has become so impacted one wonders if asking plan sponsors and record keepers to do one more thing (on top of fee disclosures, special notices, and increasingly complex DOL fiduciary rules) is more than the industry can digest. Couple this with the federal government now authorizing states to get into the 401(k) and IRA business and the market is likely to get even more confused and less efficient.
Fortunately, there is a simpler solution to this problem. Stay tuned for the answer in my next blog.
President and CEO