WASHINGTON - With 47% of 401(k) plans now using automatic enrollment, the programs have helped get millions of new workers enrolled to start saving early for retirement, but industry experts say the automatic nature of these plans needs to extend to helping "hands-off" investors when they change jobs.
When an employee leaves a job, he or she can choose to roll over their money into an individual retirement account (IRA), take a lump-sum payment minus taxes and a 10% penalty, or do nothing and leave their money in the 401(k). Sir Isaac Newton would predict the latter.
In fact, a full 43% of the assets in 401(k)s held by workers who left their jobs in the first quarter of 2008 still remain in the old plans, Charles Schwab found in an analysis it released last month.
Investment experts think the logical solution to such problematic and widespread inertia is to have plans automatically roll over former employees into a comparable IRA, preferably with the same fund company.
Terminated employees who stay in a company plan can continue to the cost fund administration company money in service calls, statement mailings and fiduciary responsibilities, said Spencer Williams, president and CEO of RolloverSystems. These maintenance costs are particularly considerable if the assets are few, which is often the case for younger employees or people who switch jobs frequently, leaving their 401(k) assets behind.
Naturally, employers stop paying for other benefits like healthcare when individuals leave a company, so continuing to provide retirement plan benefits for former employees seems illogical, many financial experts argue. To ease this burden, some plans try to encourage former employees to move into a rollover IRA, but contacting these terminated workers can be difficult.
"There is nothing worse for a plan than terminated participants," said Gregory Wood, chief operating officer at DailyAccess Corp. "It costs $2 to $4 per participant to send out information," and oftentimes it bounces back as undeliverable.
While the majority of the assets in most 401(k) plans typically belongs to a small number of high-net-worth individuals, the majority of the participants in these plans are young, low-income workers with low account balances. When these workers change jobs, they often change cities and don't leave a forwarding address.
Even with economies of scale, it is expensive for even the largest providers to provide distribution and IRA rollover service functions to these small accounts, Williams said. Removing small, dormant plans would improve the efficiency of the rest of the plans.
"On average, 8% to 12% of participants are terminated each year," Williams said. "Forty percent of terminated participants have less than $10,000 in their accounts. The costs associated with handing distribution and rollover requests create minimal economic value, particularly for lower-balance accounts."
"Naturally, advisers would love to cherry-pick the top clients and focus on revenue-producing activities," said Robert Wasky, president of Retirement Rollover Solutions. All these plans with small account balances may seem like pennies, but pennies add up.
Total rollover assets are expected to reach $2 trillion by 2013, he said.
Mutual fund companies want to keep these assets in-house, but employers don't want the expense. A solution that would make everybody happy is to automatically rollover terminated employees into an IRA that is run by the same fund company.
"Rollover assets are highly desired, but advisers need to get out in front of these transactions," Wasky said. "Automatic rollover solutions can provide cost savings of 20% at implementation and 10% to 20% annually."
Williams said that most terminated employees will roll out of a company 401(k) within five years of leaving their job, but they leave at the rate of about 50% a year.
"A terminated participant is not a one-time rollover event," he said. "Companies need to have an inventory program in place to handle rollovers when the participant is ready, which can be anywhere between right when they are terminated to five years later."
As Newton would say, the problem is with inertia.
Before the Pension Protection Act of 2006, most employees had to opt into their company's 401(k) plan, and most employees did not make this move. The result was that few people were participating in these plans, said Jim Langenwalter, chief business development officer at RolloverSystems.
When companies began automatically enrolling employees into their 401(k) plan, they typically put new employees into a very conservative, stable-value fund at a low contribution rate. Participation in 401(k)s jumped, but again, investor inertia prevailed, and most participants stayed in whatever fund they were put into.
After the PPA, companies had the option to automatically enroll new employees into a 401(k) that was invested in an age-appropriate target-date fund, with a suitable contribution rate that qualified for the company match. Once again, most employees that were put into these new plans made no changes.
When employees retire or leave a company, many tend to do whatever the default option is, even if they have better choices. If the default is to cash out and pay a penalty, they will cash out, Langenwalter said. If the default is to stay in the plan, they will stay in.
Industry leaders are seeing a pattern, and are working to develop the best-possible default options. New automatic features like auto enrollment and auto asset escalation are growing in popularity among 401(k) providers for their ability to get passive investors into a suitable product, but those features can go farther.
Target Date: Life Expectancy
401(k) planners are already talking about a revolutionary new wave of automatic features for retiring workers, such as automatic rollovers into age-appropriate target-date IRAs. For instance, a new retiree could be automatically rolled into a new type of target-date fund-aimed at carrying an investor throughout their expected lifespan-with a guaranteed income component.
Certainly, this could succeed in helping fund companies capture the expected $400 billion in annual rollovers by the end of the decade. But in the short term, many believe the automatic IRA is a step in the right direction.
"Four out of 10 Americans have money in more than three plans," Langenwalter said. "Up to 30% of total plan participants in any given plan are terminated participants."
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