DOL proposes rule to reduce leakage in 401(k) plans

The Department of Labor proposed a rule late Wednesday that’s meant to stanch the flow of money out of 401(k) plans, an issue that has long troubled retirement policymakers.

The Labor Department’s proposal promotes the idea of “auto-portability,” a mechanism that automatically reconnects plan participants with 401(k) savings they may have inadvertently left behind or forgotten about after leaving a prior employer.

Current rules allow companies to jettison the small 401(k) account balances of former employees. These cash-outs by employers, as well as voluntary cash-outs initiated by employees, represent a major source of “leakage” from 401(k) plans.

Policymakers say leakage reduces individuals’ overall retirement wealth, an effect that’s compounded by the frequency with which employees change jobs and by automatic enrollment, which creates a greater number of small plan balances.

The Government Accountability Office found that 25 million participants in workplace plans separated from an employer and left at least one account behind in the decade from 2005 to 2015, according to an October 2017 report. Millions left two or more accounts behind, the GAO found.

The Center for Retirement Research at Boston College found that 401(k) plan leakage causes a 25% reduction in aggregate retirement wealth, according to a 2015 analysis. The study looked at cash-outs as well as in-service withdrawals, such as a hardship distribution.

“Leakage is absolutely an issue,” said Marcia Wagner, principal at The Wagner Law Group. “This is probably a way for the DOL to say, 'We’re trying to do something that’s not controversial to deal with the leakage problem.’”

The DOL’s proposed rules, which only apply to account balances of less than $5,000, seek to exempt one firm, Retirement Clearinghouse, from certain restrictions under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code.

Retirement Clearinghouse has an auto-portability mechanism that identifies participants who have left an employer, rolls their small 401(k) accounts into an IRA, detects when the individual has landed at a new employer, and then automatically rolls the money into that individual’s new 401(k) plan.

This is meant to consolidate an individual’s retirement accounts that have been left behind and prevent employers from cashing out accounts of former employees. (Currently, employers can cash out accounts smaller than $1,000 by sending a check to the participant. To get rid of accounts with balances between $1,000 and $5,000, employers must roll the money into an IRA set up on the employee’s behalf.)

Retirement Clearinghouse, which is a fiduciary in its transactions, needs a rule exemption because it receives a transfer fee in connection with its services. Current rules don’t allow fiduciaries to receive additional fees for such transfers absent an individual’s consent.

The DOL said that it is only proposing to grant the exemption from these rules for five years, since the RCH program is new, and the DOL “cannot confidently determine how successful the RCH program will be at achieving its objectives.”

Comments are due by Dec. 24.

(More: Loosened rules at odds with efforts to cut 401(k) loans, hardship withdrawals)