In 2006, Congress passed the Pension Protection Act that changed the world of 401(k) plans and the retirement savers they serve. Among the many things this new law encouraged, perhaps automatic enrollment has had the most beneficial impact. It has increased the percentage of people saving for retirement.
But a recent Federal Reserve Bank of Chicago presentation may have exposed the dark side of automatic enrollment.
Retirement professionals often associate the phrase “set it and forget it” with automatic enrollment. While making it easier for employees to start saving in their company’s retirement plan (the “set it” part), the “forget it” part especially attracts participants who would rather not have to pay too much attention to the financial demands of managing their retirement investments.
Unfortunately, they may take this “forget it” part too far.
“This has led to a concern among policymakers that people may forget or lose track of these accounts,” said Shanthi Ramnath, a Senior Economist for the Federal Reserve Bank of Chicago, when she spoke at the Federal Reserve Bank of Chicago event on October 18th.
Ramnath took a look at tax return data to determine the share of abandoned IRA accounts. (She noted it’s much more difficult to collect similar data for 401(k) plans.) And while her results of .2% and .4% show “not a huge number of accounts being abandoned,” she says, “They’re still a substantial amount of someone’s income.”
David John, Senior Policy Advisor, AARP Public Policy Institute says, “A recent study found that the probability that an abandoned account is reclaimed within ten years of the participant turning 72 – the age at which people must start taking distributions from IRAs – increases with account balance, plateauing at around 60 percent for accounts larger than $3,000. Small accounts involuntarily rolled into an IRA are about 10 times more likely to be abandoned than small accounts that are not involuntarily transferred.”
“For an older person still alive, a missing account means they have money they don’t know about that they could be using to enjoy their retirement, pay for long term care or leave an inheritance to a loved one,” says Josh St. Laurent, Founder & CEO of Wealth In Yourself in South Lake Tahoe, California. “For heirs, the problem is trying to prove who the owner would have wanted as the beneficiary for the account. Typically, if you’ve forgotten your account, you have forgotten your beneficiaries as well. So now your family has to ‘battle’ in probate to collect money that was once yours.”
Forgetting your retirement account is easier than you might imagine. Remember, automatic enrollment means you don’t have to decide about joining your company’s retirement plan or how much you’ll be saving. It’s easy to forget you even have a 401(k) account. And, if you’re changing jobs frequently, it’s easy to overlook something that adds up to only a tiny amount of money.
“About seven percent of retirement plan participants are lost, meaning that they cannot be found by the holder of their money,” says John. “A greater number simply forget where their savings went, or even that they had past savings. This is especially true for accounts from early in people’s careers.”
If you don’t leave your former employer with specific instructions on what to do with your 401(k) account, what choice does the plan sponsor have?
“For accounts that have between $1,000-$5,000 in assets, they are often forced into an Individual Retirement Account (IRA),” says Matthew Compton, Managing Director of Retirement Services at Brio Benefit Consulting, Inc. in New York City. “That balance would remain until claimed by the participant or the beneficiary. In some instances, these balances may be allocated to the state until they are reclaimed. Needless to say, this is not an ideal situation for the plan participant or their beneficiary.”
Research confirms this tendency. Ramnath found that “people whose IRAs are created with this Rollover are less likely to update their address, so we think they’re less likely to find that account later on and less likely to take that RMD.”
In some cases, the IRA custodian will issue the Required Minimum Distribution (RMD) even if the owner does not request it, muddying the waters even further.
“When older participants abandon accounts in a former employer’s plan, it can present issues in terms of making sure RMDs are made as they should be,” says Kit Gleason, VP/Sr. Relationship Manager at First Bank & Trust in Sioux Falls, South Dakota. “Most providers will issue the distribution, but then the check goes uncashed, putting the sponsor and provider right back in the missing participant cycle.”
401(k) plan sponsors must make a diligent effort to distribute RMDs to plan participants. They face the same obstacles as IRA custodians.
“Abandoned accounts are an industry-wide issue,” says Jason Grantz, Managing Director at Integrated Pension Services in Highland Park, New Jersey. “Employers are required to try to find these former employees and get some type of affirmative instruction from them on what to do with their retirement funds. And that can be challenging for employers, especially over time, and for heirs when trying to settle the estate or when having to do difficult things like getting copies of death certificates and the like.”
Before your heirs even get to the task of proving their right to access the funds, they must first know that there are funds they have a right to access.
“The biggest problem is recognizing the account even exists,” says Tim Wood, Principal at Foster & Wood Investment Fiduciaries in Lake Oswego, Oregon. “I am not certain that anyone lists their previous employers in their wills to provide their heirs with some hints about where assets might be. Further, when people move, in my experience, they very rarely update their former employer of their new address to ensure quarterly statements are being received.”
Is there anything akin to a central repository of information that might provide a clue regarding forgotten retirement accounts?
“If one does not keep track of their personal assets, it is always a problem for the survivors,” says Dick Billings, Senior Document and Compliance Specialist at PCS Retirement, LLC in Philadelphia. “Plan Sponsors are currently required to file IRS Form 8955-SSA with Social Security if they do not apply for their benefits. When a participant, or their survivor, applies for their Social Security benefits, they will be notified of the existence of this past benefit. Here is a common problem. Between termination of employment and receiving Social Security benefits, employees receive their old 401(k) balance but forget about it (probably because it was a small amount). Benefits are then requested again because Social Security tells the survivors that an old balance exists.”
In case you have any doubts, the consequences of forgetting your retirement plan can get worse. It may cost your heirs a portion of their inheritance.
“If older workers forget that they are entitled to a plan distribution, and a plan sponsor cannot locate them, even after following all of the recommended steps indicated by the IRS and the DOL to locate missing plan participants, some plans will provide that their benefits under the plan are forfeited, subject to restoration if the participant subsequently requests a distribution, while other plans provide that the account balance be escheated to the relevant jurisdiction, although this is a controversial option that the DOL believes should be preempted by ERISA,” says Marcia S. Wagner, Managing Member of The Wagner Law Group in Boston. “After a participant’s death, the default beneficiary, after the participant’s spouse, maybe the participant’s estate, (although a plan may provide an ordering of beneficiaries after the spouse, such as parents, children, siblings, etc., with the participant’s estate as the last option, and in some instances, even if the participant’s estate is the default beneficiary), an estate will not be opened after the participant’s death, a circumstance that may not explicitly be addressed under the plan. If a participant died after the date that benefits under the plan should have begun to him or her, then a portion of the participant’s benefits will be paid to the estate as income in respect of a decedent, with only the remainder available to the beneficiaries. Also, heirs may face practical problems: the plan might have been terminated, or the plan sponsor acquired by another company with the plan of the former employer merged with the new employer’s plans. Depending upon the relationship, a participant’s heirs may have some difficulty proving the relationship, and it may be difficult for some relatives to obtain a copy of the participant’s death certificate.”
Gleason recalls going through such a can of worms. “The biggest issue I see for heirs is simply identifying and locating accounts their loved one left behind,” she says. “I recently worked with a participant whose mother had passed and had left funds in a former employer’s plan. She knew this only because they had discussions about it before her mother passed. Her mother’s former employer had been purchased by a company who had fairly recently become a client of ours, but no balance or records had been sent to us in her mother’s name. The daughter knew there had been a balance and that it had not been distributed to her mother, so she kept calling anyone who could have been associated with the account but was getting nowhere. I had sympathy for her situation, so I reached out to the plan’s former TPA to see if they had any information and we were finally able to locate the account, which had been forced out to an IRA prior to the plan transferring to us. It shouldn’t have been that difficult, so I’m hoping perhaps the proposed national database could make this a bit easier in the future though that remains to be seen.”
It doesn’t help that the current rules present impediments to consolidating your IRA assets. It’s not impossible, but it resembles a labyrinth most people might find daunting.
“One reason for lost accounts is that a forest of often well-meaning regulations and industry practices make it very difficult for people to move their retirement savings from one employer to another,” says John. “While a financial professional can often navigate those obstacles, it is extremely difficult for anyone else to do so.”
Policymakers are talking about the concept of a “Universal IRA,” whereby an employee’s retirement plan would automatically follow the employee from employer to employer.
“It requires some coordination among employers,” says Enrichetta Ravina, Senior Economist at the Federal Reserve Bank of Chicago. “A centralized system would definitely be good. There would be some cost to implement it, but I would argue the cost would be smaller relative to the potential benefit.”
This idea is not new. It has been written about as early as 2010, but the wheels of progress, even with bipartisan support, roll slowly at best.