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In December 2014, the Government Accountability Office released a report, 401(K) Plans – Greater Protections Needed for Forced Transfers and Inactive Accounts. The report is generally critical of the current procedures for ‘forced’ 401(k) plan rollovers – generally transfers (sometimes called ‘cash-outs’) of balances of $5,000 or less to an IRA without the participant’s consent. In this article we review the report and the GAO’s recommendations.
This report is part of an increasing focus by policymakers on issues related to rollovers. That increase in focus is in part the result of increased baby-boom retirements and increasing workforce mobility. Sub-issues in this area include leakage (e.g., last year’s ERISA Advisory Committee on Lifetime Plan Participation), conflicts of interest (e.g., 2011’s GAO report 401(K) Plans — Improved Regulation Could Better Protect Participants from Conflicts of Interest and the much anticipated re-proposal of DOL’s re-definition of ‘fiduciary’ under ERISA), and problems with the current rollover process (e.g., GAO’s 2013 report 401(K) Plans — Labor and IRS Could Improve the Rollover Process for Participants).
GAO’s latest report focuses on process, and specifically what happens to money that is ‘forced out’ of 401(k) plans and transferred to an IRA.
Generally (and oversimplifying somewhat), a 401(k) plan may ‘cash out,’ that is, distribute without the participant’s consent, amounts up to $5,000. If the participant’s benefit is greater than $1,000, and the participant does not elect otherwise, the cash-out must be distributed to an individual retirement account (IRA) or individual retirement annuity (IRA-annuity).
These cash-outs generally occur with respect to terminated participants who sometimes are, in effect, ‘lost’ – so that the chance of the participant either consenting to a cash distribution or designating her own IRA is remote. Pursuant to the 2001 legislation adding to the Tax Code the rule requiring that non-consensual cash-outs of amounts over $1,000 be transferred to an IRA or IRA-annuity, DOL regulations provide a fiduciary safe harbor for sponsor selection of an IRA or IRA-annuity provider. Generally that safe harbor requires that the plan fiduciary enter into an agreement with the IRA provider that provides that:
Funds are invested in an investment product designed to preserve principal and provide a reasonable rate of return.
The investment product selected seeks to maintain, over the term of the investment, the dollar value of the original investment.
The investment product selected is offered by a state- or federally-regulated financial institution.
Fees and expenses do not exceed the fees and expenses charged for comparable IRAs.
The participant has the right to enforce the terms of the contract.
In practice, these cash-outs are typically rolled over to IRAs (rather than IRA-annuities), and the IRA-provider is taking what are typically small amounts as an accommodation to the sponsor.
GAO was critical of several aspects of current ‘forced transfer’ practice:
GAO found that forced transfer amounts were typically invested in low-risk/low-return investments, e.g., money market funds and certificates of deposit. Fees, relative to the size of the account and to returns, were high. As a result, the account balance held in forced-transfer IRAs decreased over time, going to $0 in as short as 9 years.
Because rollovers are disregarded in determining whether a participant’s benefit is $5,000 or less, participants with total balances significantly in excess of $5,000 can be cashed out.
As noted in GAO’s 2013 report 401(K) Plans – Labor and IRS Could Improve the Rollover Process for Participants, under current rules “there are barriers to plan-to-plan rollovers” which make it hard for participants to consolidate accounts with their current employer.
Keeping track of balances in and distributions from the plans of prior employers is difficult for participants. Current rules require multiple and sometimes confusing disclosures. Both the former employer (who may go through various identity changes including mergers, spinoffs and even bankruptcy) and the former employee (who may change addresses several times) have a hard time keeping track of each other.
The government facilities for finding lost employees or lost employers – including at the DOL Office of Outreach, Education, and Assistance, the Health and Human Services Administration on Aging and the Social Security Administration (SSA) – are generally ad hoc, uncoordinated and do not provide a systematic way for participants to track down benefits owed them. And the Pension Benefit Guaranty Corporation has not implemented the PPA’s provision that it establish a missing participant program.
GAO looked at how the issue of small accounts for terminated participants and ‘forced transfers'” was handled in the United Kingdom, Switzerland, and Australia. In each of those countries, in contrast to the current US system, “forced transfers … follow participants changing jobs, are efficiently managed in a single fund, or are free from fees at a government agency. Each of these approaches helps to preserve the real value of the account for the participant, and generally ensures workplace plans will not be left with the expenses of administering small, inactive retirement accounts.”
With respect to the issue of tracking benefits, the Netherlands, Australia, and Denmark provide pension registries. Belgium is implementing a pension registry in 2016. And the European Union is developing a Europe-wide pension registry. Generally these pension registries provide data on both active and inactive accounts via a website, making the process of tracking down “lost” benefits relatively easy.
To address the issues it identified, GAO recommended:
Changing current rules (by legislation if necessary) to “allow plans or regulators to develop or consider additional default destinations when employees are forced out,” possibly along the lines of the qualified default investment alternative (QDIA) rules, which allow defaulting to, e.g., a target date fund. This, GAO theorizes, would allow forced-out balances to earn enough returns to cover expenses. DOL indicated that it did not believe it had authority under current law to do this.
Counting rollovers against the $5,000 limit on forced cash-outs.
That the SSA more aggressively communicate to employees the “critical information on accounts left in former employers’ plans” that the SSA holds. The SSA disagreed with this recommendation, saying that it was concerned that it would “place the agency in the position of having to respond to public queries about ERISA.”
Creating a pension registry in the US.
The ongoing ability of sponsors to ‘clean out’ small accounts of former participants from 401(k) plans is clearly valuable. Citing a 2011 survey by the Plan Sponsor Council of America, GAO reports that “about half of active 401(k) plans force out separated participants with balances of $1,000 to $5,000.”
It’s unclear whether taking away the ability to disregard rollovers in making the $5,000-or-under determination would make plan administration more difficult. If it did, then making that change would, among other things, discourage plans from taking rollovers in the first place. This issue probably needs more study.
Dealing with missing participants remains, for sponsors, a chronic problem – for the half of sponsors that do not force cash-outs and for balances over $5,000. It would certainly be helpful if the SSA made a greater effort to help connect lost participants with lost benefits or if the PBGC finally implemented a missing participant program for DC plans.
In the 21st century, it certainly seems that building a single pension registry, that would allow both employees and employers to track benefits across employers and across time, would be an ideal solution. But experience with, e.g., the Affordable Care Act website, suggests that doing so may be harder than it appears. Given the success of pension registries in Europe and Australia, however, it seems to be an idea worth exploring.
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The report was requested by Senators Harkin (D-IA) and Warren (D-MA). Senator Harkin has retired; his replacement (the new Ranking Member on the Senate Health, Education, Labor and Pensions Committee) is Patty Murray (D-WA). It’s not clear whether Senator Warren or Senator Murray will continue to push this issue. But as noted at the beginning, rollovers are getting increased policymaker focus, and the issue of ‘forced transfers’ is not one on which there is an obvious partisan divide.
We will continue to follow this issue.