Exploring the Lost Opportunities of Small IRA Rollovers

During a Tuesday webinar hosted by the Employee Benefit Research Institute (EBRI), titled “Big Challenges with Small IRAs,” Craig Copeland, EBRI senior research associate, noted that safe harbor regulations require that 401(k) assets of less than $5,000 that plan sponsors can roll over to an individual retirement account (IRA) must be invested in a money market fund or other money market account. The real problem with this is that few participants change these investments, Copeland said. As a result, 75.9% of IRAs with balances of less than $5,000 are in money market funds, he said. Among IRAs with less than $5,000 that have been rolled over from a 401(k), 76.7% of the assets are in money market funds, Copeland said.

This is a very pervasive problem, he said. More than one-fifth (22.1%) of IRAs have less than $5,000, and 20.7% of individuals have IRAs with less than $5,000. “The bulk of the owners are between the ages of 25 and 44,” Copeland said. “They have 20 years or more until retirement. These accounts are not being closed. Asset allocation is not being changed, and they are not receiving contributions. There are missed opportunities here.”

Spencer Williams, president and CEO of Retirement Clearinghouse, said, “Americans change jobs about every five years on average. Every year, 2.4 million participants who change jobs with an account balance of less than $5,000 preserve their savings in an IRA, but 2.9 million participants cash out at the time of a job change. With the taxes and penalties they face, they receive only 40% of their money. Small accounts are actually a big problem.”

This is why Retirement Clearinghouse created automatic portability, which, Williams said, will be rolling out at a major employer in the first quarter of next year. This system automatically transports these small accounts from a prior 401(k) or IRA into the participant’s new 401(k) at a new employer. The Department of Labor (DOL) issued guidance in July 2019 permitting employers to adopt auto-portability as long as they permit participants to opt out, Williams noted. “This is a solution that attempts to take advantage of inertia to create better behaviors and outcomes,” he said.

Courtney Eccles, director of the Secure Choice Savings Program in Illinois, which is the state’s auto-IRA program, said small IRA rollover programs could be structured like Illinois’ auto-IRA program. Employers with 25 or more employees just have to register for the program, enroll all their employees in it and set up the payroll deduction, Eccles said. “They don’t have to handle reporting and are not fiduciaries. Rather, they are simply facilitators.”

Workers are automatically enrolled into the program with an opt-out provision. For the first 90 days, their money is put into a capital preservation fund, after which time it is moved into a BlackRock target-date fund (TDF), the LifePath Index Series. BlackRock also offers growth, conservative and aggressive funds if the participant doesn’t want to be in the TDF.

“Defaults work, and TDFs allow for growth,” Eccles said. “Portability allows for fewer lost accounts. When a worker is added by a new employer, they are connected to their existing account. Lessons from state auto-IRA programs can shape future decisions around defaults for small dollar rollover IRAs.”