Why You Should Clean Up Those Old 401(k)s

Accumulating the savings you’ll need in retirement is tough enough. Don’t make it tougher by leaving behind a trail of abandoned 401(k) accounts when you change jobs.

If you have one of these orphan 401(k)s, you’re not alone. One study estimates about $1.65 trillion is sitting in abandoned accounts, representing the savings of 30 million workers.

The problem is most acute for people who leave behind small accounts. Employers are permitted to transfer orphan accounts that hold less than $7,000 into IRAs that may earn low returns in money market funds and charge high fees—and most do so to trim plan administration costs. Over time, these accounts can simply waste away.

Increased job switching has accelerated the issue. The current tight labor market makes it easy for people to shift jobs more frequently as employers compete for talent, and the average American worker will have 12 jobs throughout her lifetime, about 4.1 years each.

The antidote to diminishing returns on these retirement accounts is adopting good 401(k) hygiene. When you leave a job, you have four options:

• Leave the balance in the old plan.
• Move the balance to your new employer’s plan.
• Move the balance to an IRA.
• Cash out the balance.

The last option is the least desirable, especially for younger workers. Withdrawals are subject to a 10% penalty if you’re younger than age 59 ½, with some exceptions. Any of the other three choices might make sense for you, depending on your circumstances.

Also, be aware of regulatory and industry changes that could affect your orphan 401(k)s.

What Secure 2.0 Means for Orphan 401(k)s

The Secure 2.0 retirement law incorporated several major changes to the treatment of orphan 401(k)s.

One major change is that the balance requirement for an employer to execute an automatic rollover to an IRA has been raised to $7,000 from $5,000, beginning this year. This means that more small accounts will be subject to automatic transfer.

Secure 2.0 also includes legislation dubbed the Retirement Savings Lost and Found Act, which was proposed by Sen. Elizabeth Warren of Massachusetts. The bill instructs the US Labor Department to create by the end of this year a database that workers can use to locate forgotten accounts. The department was allotted funds to create the system by December; this first-of-its-kind online tool will provide people with contact information for plan administrators of their left-behind retirement accounts, and employers are required to share information with the Labor Department to keep the database up-to-date.

401(k) Automation Extends to Rollovers

Automation has been a key trend in defined-benefit plans for the past two decades, with many plan sponsors adopting auto-enrollment, auto-escalation of contribution rates, and target-date funds. Now, the financial-services industry has also created a cooperative venture that will automatically move your old retirement account into a new employer’s plan if you don’t take proactive steps on your own.

The Portability Services Network is a collective of major administrators (Alight Solutions, Empower, Fidelity Investments, Principal, TIAA, and Vanguard) that together administer and hold the records for 63% of US plan participants, according to Neal Ringquist, executive vice president and chief revenue officer at Retirement Clearinghouse, the company that is leading creation of the network and providing the technology. Discussions are underway with other major recordkeepers, and most are expected to join.

Ringquist notes that small accounts are cashing out at very high rates. “It’s about 55% in the first year after an employee leaves, and around 75% of these accounts are gone after seven years,” he says. “Our goal is to instead see these accounts retained in the retirement system.”

The network also aims to address a specific problem with cash-outs—namely, that they are made predominantly by lower-income workers of color. Ringquist says, “Underserved African American and Hispanic plan participants are cashing out at much higher rates, so auto-portability can help bridge the minority wealth gap by plugging cash-out leakage.” And research by the Employee Benefit Research Institute found that auto-portability decreases retirement savings deficits for women.

What about people who leave a job but don’t immediately go to a new one, or go to a job where no retirement plan is offered? In those situations, orphan accounts may still move to a safe-harbor IRA, and the network will do weekly queries to check on that worker’s status. If she regains access to a workplace plan, the IRA will be transferred automatically.

What to Do to Manage Your Old 401(k)s

Automated transfer systems represent progress, but they don’t address two problems that need to be addressed proactively by retirement savers as they change jobs throughout their careers.

• Not all 401(k) plans are created equal. Large employers tend to have strong plans featuring low costs and solid investment menus. Small employers often have mediocre to poor offerings plagued by high costs and lousy investment choices.
• Safe-harbor IRAs are no place to be. Employers need to use these accounts as defaults when they transfer you out of their plans to meet legal requirements. But the funds are invested in low-yield money market funds that often don’t generate enough in returns to even offset fees.

For these reasons, it makes sense to take action yourself. Simply establish a single, low-cost IRA where you can roll over smaller balances as you move through various jobs. This can be a good way to stay organized and avoid losing track of your money.

But do this carefully. IRAs don’t come with the same fiduciary protections afforded by 401(k) plans. Fees can vary greatly, and the difference can cost you dearly over the course of retirement.

Either way, it pays to stay well-organized with your retirement savings throughout your working years.

“The fewer accounts you have, there will be fewer opportunities for bad actors to get access to your balances,” says Ringquist. “And it’s easier to manage assets and rebalance when you stay consolidated. Consolidation produces more favorable outcomes, so it’s an excellent practice.”