Will 401k Auto-Portability Became a Cure-All or a Fiduciary Headache?

Will 401k Auto-Portability Became a Cure-All or a Fiduciary Headache?

January 09, 2024

Check out my contribution to an article published in Fiduciary News...

Will 401k Auto-Portability Became a Cure-All or a Fiduciary Headache?
by Christopher Carosa January 09, 2024

The turn of the calendar brings many things, and the turn of a new year brings more. Effective January 1, 2024, plan sponsors will find there’s a new twist on an old familiar thing. It’s called “auto-portability.” Some believe it’s destined to become a cure-all for much of what ails retirement savings today. Others, well, they’re not so sure.

“Auto-portability refers to the movement, upon notice to plan participants and their having no objection, of a participant’s account balance in a former employer’s plan to a rollover account in a new employer’s plan,” says Marcia S. Wagner of The Wagner Law Group in Boston, Massachusetts. “It is designed to address the issues of plan leakage and participants forgetting about account balances in the plans of former employers, which can be addressed in part by having their account balances consolidated. Under present law, a plan sponsor can cash out participants in an individual account plan such as a 401k plan, if their account balance is $7,000 or less. In these circumstances, some participants elect to receive a distribution in cash, which is not only includible in gross income but subject to a ten percent (10%) excise tax if they are younger than 59½. rather than transferring their account balance to a new employer’s plan or into an IRA. This action on the part of plan participants is referred to as leakage, because of the loss of tax deferred earnings had the funds remained in a tax qualified plan or an IRA.”

While precise, that’s a mouthful. Lawrence (Larry) Starr; executive VP at Cornerstone Retirement/QPC in West Springfield Massachusetts, prefers Bloomberg’s explanation. “I think this definition from Bloomberg is on target as to what the NEW auto portability discussion/Secure 2.0 provision is all about: ‘SECURE 2.0 Act eliminates the legal uncertainty that’s been swirling for years around the concept of moving former workers’ money without their express consent. Employers that are left with these benefits can now automatically transfer them to the ex-employee’s new job.’”

“Auto portability is in the news right now because, as of January 1, 2024, the auto portability provisions in SECURE 2.0 were codified into law,” says Donna M. Stefans, lead attorney & registered representative at Wealth Advisory Associates in Woodbury, New York. “The rules for auto portability are now in place, and both plan sponsors and employers must start applying this new process.”

But there’s more to it than simply the SECURE 2.0 Act’s effective date.

“Last week, Retirement Clearing House released key findings from its auto portability simulation which modeled the adoption of auto portability within the U.S. defined contribution retirement plan system over a 40-year period,” says Michelle Capezza, of counsel at Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. in New York City. “Their key findings included that there will be significantly more job changers with small balances subject to mandatory distribution rules, auto portability services will dramatically reduce cashout leakage, and they will help to grow incremental wealth as well as retirement plan participation of minority populations. In December 2023, the Department of Labor also submitted to the White House Office of Management and Budget for review a Notice of Proposed Rulemaking to implement a statutory exemption under Section 4975 of the Internal Revenue Code allowing for an automatic portability provider to receive fees and compensation for services provided in connection with automatic portability transactions.”

With all this hype, you’d think folks have been waiting for the benefit. In fact, auto-portability does offer plenty of advantages, especially to plan participants.

“The purported benefit is that the adoption of this provision can reduce the so-called ‘leakage’ of retirement funds being cashed out when someone moves to a new employer and is not kept for ultimate retirement usage,” says Starr. “Also, it can make the process simple for the participant (it might end up being a simple button for the employee to elect the automatic rollover to the employee’s new employer).”

It is this “one-button” concept that might be auto-portability’s greatest advantage.

“The main benefit to plan participants is that it is automatic, so they don’t have to take an action to facilitate it. As we’ve seen with other automatic or automated plan features, the less the participants must do anything for the action to occur, the more likely that action actually does happen,” says Jason Grantz, managing director at Integrated Pension Services in Highland Park, New Jersey. “If consolidating accounts is in the best interest of the participant, and the vendors feel it’s good for them as well, it will have legs.”

If solving leakage and encouraging consolidation works, employees can look forward to a bigger payday when they retire.

“Auto portability encourages retirement savers to save more,” says Stefans. “It is anticipated that over the next 40 years, more than $1.5 Trillion dollars in retirement contributions would be saved. People would have a nest egg in retirement!”

Don’t forget how this new structure can also aid plan sponsors.

“Plan sponsors will benefit from auto-enrollment through reduced administration expenses incurred supporting inactive accounts,” says Michelle Riiska, financial planning services consultant at eMoney Advisor in Radnor, Pennsylvania. “Another benefit is the reduced fiduciary liability risk incurred by automatic cash-outs of plans under $1000. Auto-portability will also benefit sponsors by boosting employee financial wellness as participants are able to keep their balances consolidated and appropriately invested.”

Alas, for every Yin there’s a Yang. Auto-portability may have a dark side. But is the risk enough to overcome the reward?

First, for all its ease, for all its clarifying language and mandatory disclosure, auto-portability may suffer from the same problem that afflicts all good intentions: plan participants don’t read the instructions.

“Auto-portability is based upon negative consent,” says Wagner. “A participant will be informed that his or her account balance will be rolled over from his or her former employer’s plan or from a default IRA into the tax qualified plan of his or her new employer unless he or she indicates that the rollover should not be affected. No matter how clear the language of the notification to plan participants, individuals receive so many communications that there can be no assurance that the participant will pay sufficient attention to the decision. While the decision may be beneficial to implement the auto-portability transaction will be beneficial to many participants, that will not always be the case. Further, there will be fees associated with implementing an auto-portability transaction, although those fees cannot be in excess of reasonable compensation.”

While “one-button” sounds great, we all know there’s no such thing as a one-size-fits-all solution.

“Auto-portability is a slippery slope,” says Richard Bavetz, investment advisor at Carington Financial in Westlake Village, California. “Where does it end? There is a consistent and increasing pattern of government overreach that doesn’t seem to have a brake pedal. The government claims this will help plan participants and maybe to some extent it will, but the help they say they are providing looks a lot like control. They are systematically enacting provisions that put a fence around the retirement money of American workers and in the process, they are regulating smaller advisory firms, individual advisors, and fiduciaries right out of business. Since when have any of the large wire houses been concerned about the best interests of workers? One can envision workers being at the mercy of a cartel of financial institutions coordinated by the government to limit the free movement of an individual’s retirement savings. This is already happening right before our eyes. Prohibited Transaction Exemptions could simply be regulated into Prohibited Transactions, and so on. I’m reminded of one very popular former president who famously said that the nine most dangerous words in the English language are, ‘I’m from the government and I’m here to help.’”

On the plan sponsor side of the equation, things just got a little more complicated.

“There is an ‘opportunity cost,’” says Jack Towarnicky, of counsel at Koehler Fitzgerald, LLC in Powell, Ohio. “Today, one of every five 401k accounts belongs to an individual who is term vested or retired. That’s a lot of assets, especially because these may be individuals who have a lifetime of savings in the plan, sometimes totaling in six or seven digits. It is those jumbo-sized account balances that help to keep fees reasonable for the rest of the participants. Because you can’t force out distributions where the account balance is in excess of $7,000, a plan sponsor will almost always have to accommodate processing for term vested or retired participants. So, some plan sponsors have decided to retain assets and accounts.”

With these complications come those dreaded liabilities.

“The problem from a plan sponsor perspective is that there are fiduciary responsibilities associated with engaging any service provider to the plan,” says Wagner. The services must be necessary for the administration of the plan, and the compensation paid to the service provider must be reasonable. Further, since the party providing the auto-portability services is a plan fiduciary (under SECURE 2.0), there is a concern about potential co-fiduciary liability. As far as the benefits to the plan of reducing leakage, a plan sponsor might also believe that, with respect to the demographics of its plan, is the use of hardship withdrawals and unrepaid loans upon separation from service, as well as the SECURE 2.0 provisions for withdrawal of certain emergency expenses and the provision for emergency savings accounts linked to individual account plans.”

Does this mean auto-portability will become another in a long string of “be careful what you wish for” regrets? We’ll know sooner than you think.

Christopher Carosa is an award-winning online news producer and journalist. A dynamic speaker, he’s the author of 401(k) Fiduciary Solutions, Hey! What’s My Number? How to Improve the Odds You Will Retire in Comfort, From Cradle to Retirement: The Child IRA, and several other books.