Auto 401(k) Plans Continue to Evolve—Addressing Small Account Concerns

Automatic 401(k)s continue to enjoy strong acceptance among employers of all sizes. Organizations view features such as automatic enrollment and auto-escalation as powerful tools to help maximize enrollment and help employees effectively save for their future.

That does not mean automatic plan design is free of concerns. One of the thornier issues is how to deal with many accounts with small balances. Small account balances can become a problem when participants leave their employer—and their accounts—behind. Many participants fail to keep former employers aware of their new address(es). Growth in automatic 401(k) plan design, combined with a more transitory workforce and the economic downturn, has led to even more small accounts without participants to readily claim them.

The good news is that the small account issue is becoming more manageable, and a steady increase in adoption rates for automatic features such as auto-enrollment suggest small accounts are not seen as a significant barrier to rolling out automatic features. Government regulations that provide clear guidance to employers with respect to small accounts, as well as opportunities for fiduciary relief, have given employers more confidence in using automatic rollovers. In addition, plan administrators and others within the financial services industry are providing services and solutions to facilitate the auto-rollover process.

Automatic 401(k) Plan Design in Brief

Growth in automatic 401(k) plan design was spurred by enactment of the 2006 Pension Protection Act. This law and ensuing regulations paved the way for defined contribution plan sponsors to set up automatic defaults. With this design, employees are automatically enrolled in the plan at a set contribution rate. Contributions go into a default investment fund the plan sponsor selects. In many plans, employee contributions automatically go up each year (automatic escalation).

Automatic plan design features intend to cancel out the inertia that prevents employee participation. Deloitte’s latest 401(k) benchmarking survey shows 49 percent of plan sponsors have adopted automatic features.

Small Account Conundrum

But what happens when an employee leaves a company that sponsors a 401(k) plan? As with traditional plan design, the employer is responsible under Department of Labor (DOL) regulations to treat the former employees as it treats current participants. “The former employees require the same attention as current participants,” says Terry Dunne, Senior Vice President, Automatic Rollovers for the Millennium Trust Company, an early proponent and provider of automatic rollover services. “The same fiduciary responsibilities apply to former employees that remain participants of the plan.” The employer must continue to communicate required plan information, ensure a valid investment election is on file and manage death benefit distributions to beneficiaries when applicable. If former employees move or otherwise fail to respond to communication, the plan sponsor must try to track them down. Failure to take these actions can result in fines, penalties and possibly lawsuits.

Plan sponsors may be wary of a growth in left-behind small account balances, given the continued fiduciary liability exposure they represent. This concern may get in the way of automatic plan design adoption. But a combination of a law currently on the books and interest in these accounts by the financial services industry can minimize this concern.

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and Department of Labor regulations released in 2004 enabled plan sponsors to move certain accounts to an IRA custodian. EGTRRA and the regulations allow plan sponsors to set up Automatic Rollover IRAs for participant balances between $1,000 and $5,000 in value, rather than cash them out. If the separated participant doesn’t elect another option after the plan sponsor sends out a notification letter, the IRA rollover with a custodian can be used.

Importantly, DOL regulations created a safe harbor from fiduciary liability for plan sponsors. It protects sponsors from liability with respect to selection of a service provider and selection of the investment. This guidance, combined with an increase in automatic plan design and technologies that ease the management of small accounts, encouraged service providers to begin offering automatic rollovers—and it prompted plan sponsors to make the decision to make use of this latest automatic feature.

Jim Boyd, Vice President of Centier Bank’s Wealth Management Services explains, “The safe harbor and early adoption by some plan sponsors paved the way for other sponsors to move forward with automatic rollovers.” Thousands of companies, big and small, are now using automatic rollovers to help deal with their missing and non-responsive participants. Automatic rollovers are the preferred distribution choice of the DOL for missing or non-responsive participants since the retirement and tax deferral benefits for the participants are maintained by the automatic rollover IRA. Some of the IRA custodians have effective search tools to find current addresses and most offer their custody services at modest fees to the participants.

How Automatic Rollovers Work

In order to establish automatic rollovers, plan documents have to allow for it. If not, the sponsor will need to amend the documents and notify participants of the change before moving forward.

If the plan documents are in place, and after a plan sponsor has tried with due diligence but failed to contact ex-employees, it can establish automatic rollovers. The Department of Labor requires the sponsor to enter into a formal rollover agreement with an IRA provider. The sponsor then provides pertinent data to the provider. This includes each participant’s name, last known address, Social Security number, birth date and account balance.

The provider uses the data to set up a Traditional or Roth IRA in each individual’s name. Next, the plan sponsor sends the funds from participant accounts to the IRA custodian. Once the balances are credited to each IRA, the provider notifies the plan sponsor. Fund selection is limited to principal preservation and liquid (immediately available) options. As long as the plan sponsor follows DOL guidance, these former-employees are no longer considered plan participants.

Fees and Other Rollover Realities Fees are a reality of all 401(k)s. While an IRA provider may not charge more in fees and expenses for rollover plan customers than it would to its other individual retirement plan customers,* the reality is that fees can exact a heavy toll on small accounts. A $30 annual fee on a $3,000 account translates into a full 1 percent reduction of the account value each year, and does not even include management fees that the participant must pay. Another reality is that some plan sponsors will opt to move all small accounts to a new service provider—not just missing and unresponsive accounts—even though some participants may prefer that their savings stay with the former employer. It’s a sound practice to address these realities in communications to former employees. Consider including: An upfront discussion of why the account is being moved, recognizing that not all employees may want their account rolled to another provider. Information about the default investment into which the rollover savings will be placed. An explanation of fees, including one-time and annual fees and expense ratios, which will vary by fund. An important message is that all investments carry fees, and that these fees have an impact on investment performance. An acknowledgement that the combination of fees and conservative investment options may result in savings that do not keep pace with inflation. *Department of Labor, What You Should Know About Your Retirement Plan

Questions to Ask Potential Rollover Custodians

To find out which financial services companies offer automatic rollovers, check with employee benefits or retirement trade groups, such as the Profit Sharing/401(k) Council of America (www.psca.org) or ASPPA (www.asppa.org).

Here are a few key questions the service provider should answer before you make your selection:

1. Will the provider accept all account balances $5,000 and under? Look for a custodian willing to accept all your eligible accounts. Some won’t accept accounts with balances below $1,000.
   
   
2. How will the provider support the plan sponsor in managing the process? Look for a provider that offers ease of administration. Find out if they can provide model plan language if your plan needs to be amended, and a model Summary of Material Modification.
   
   
3. What is the process for transferring the data on each former employee participant? Make sure the provider has the technology in place to handle the electronic transfer of participant information and funds. It needs to be able to handle a large number of accounts up front, and manage the ongoing transfer of accounts from plan sponsors.
   
   
4. How is the service provider compensated? Providers of auto-rollover services generally charge a fee to the plan sponsor for transfers. A one-time transfer fee of $25 to $35 is common, often picked up by the plan sponsor, and an annual fee of $25 to $35 thereafter, paid by the plan participant.
   
   
5. What is the service provider’s experience in the automatic rollover arena? As with other service providers to your plan, an automatic rollover custodian should be able to show you a proven track record, and offer client contacts if you wish to learn about their experiences with the custodian.
   
   
6. What client service does the IRA provider offer to the participants and do they search regularly for the participants? Some IRA custodians offer client service representatives by phone and email. Some offer participants web access to their account information. A big advantage to automatic rollovers is that some custodians have effective search tools and can readily reunite participants with their retirement balances.
   
   

How best to manage small account balances, particularly those of employees that leave an organization, factors into the automatic 401(k) decision-making process. Making use of another automatic process—the automatic rollover—is helping a growing number of companies effectively manage their small account responsibilities.

Additional Resources

Department of Labor Field Assistance Bulletin 2004-02, Fiduciary Duties and Missing Participants in Terminated Defined Contribution Plans