Moving Assets: Automatic 401(K) Rollovers

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Since 2005, defined contribution retirement plan sponsors have had the option to automatically roll over the plan assets of departing employees into individual retirement accounts if those accounts are worth between $1,000 and $5,000. Before this change, plan sponsors used to pay lump sums for balances less than $5,000.

"The goal for the change was to prevent leakage of retirement plan assets," which occurs when funds are paid out and taxed as distributions, says Bill McClain, a principal with Mercer consulting company in Seattle.

During the recession, executives at struggling companies turned to layoffs to reduce fixed costs. As a result, many plan sponsors found themselves with large numbers of terminated 401(k), 403(b) or similar plan participants. More administrative resources often are required to track down terminated plan participants for purposes of communication and administration. It is the plan sponsor's fiduciary obligation to communicate equally with any plan participant, terminated or active.

"It can be difficult and time-consuming to keep up with people who have left the company," says Terry Dunne, managing director of automatic rollovers for Millennium Trust in Oak Brook, Ill., adding that plans could fall out of compliance if plan sponsors "are not communicating successfully with all of their participants."

By implementing automatic rollovers, plan sponsors are looking to reduce administrative time and costs, Dunne says. Such plan sponsors "do not want to spend time on people who are no longer with the company, especially as their available resources are stretched thinner."

Managing the 401(k) Rollover Process When it comes to implementing automatic rollovers, 401(k) plan sponsors can follow a four-step process: Amend the plan document to include the automatic rollover provision. Communicate the amendment to participants.  Find an appropriate provider of individual retirement accounts (IRAs). Notify affected participants. Plan sponsors might want to consider an amendment stating that "lost" participants will forfeit account balances of less than $1,000 and will allow those funds to be absorbed into the plan. In these situations, the plan can reinstate that balance if the lost participants get back in touch with the plan. In this situation, a participant is considered lost when he or she does not respond to the plan sponsor's attempt to contact—by sending a certified letter with a return receipt requested, for instance. Once the amendment process is complete, plan sponsors must communicate the change to participants, including what the provision involves and what will happen when the provision is triggered by a departing employee. Affected participants must be notified before any rollovers occur. When it comes to choosing a provider of IRAs, the plan sponsor has a fiduciary responsibility to conduct due diligence on the provider; its fees, services and investment options; and the default investment for rollovers for lost participants who do not make their own investment selections. Because transparency around all types of plan fees has become a major concern for plan sponsors, choose a rollover solution with an appropriate fee structure. Review contracts to make sure the terms of the arrangement are reasonable, and generally conduct the same due diligence that would be appropriate for any other plan service provider. If the plan's current service provider is unable or unwilling to manage the automatic rollover process, the plan sponsor should ask the provider for a list of vendors that offer that service. Many plan sponsors use a vendor with whom they have an existing relationship because due diligence on that provider has already been completed; otherwise, they can analyze candidates based on the best cost relative to the available investment options.

In or Out?

For many plan sponsors, automatic rollovers remove small account balances that add to plan costs. Some plans pay a per-participant fee that is increased by having a large number of these balances. "Average account balance is one of the biggest measures providers use when setting pricing, so having a lot of small balances pulls down average account balance even though it does increase the amount of overall plan assets," McClain explains.

In addition, if plan sponsors lose track of individuals who move without providing a forwarding address or other contact information, the plan sponsor must track down those participants, adding time and expense. "With automatic rollovers, that burden gets transferred" to the individual retirement account (IRA) plan provider, says Marina Edwards, senior consultant in the governance and compliance advisory group at Towers Watson in Chicago.

Layoffs and other types of employee departures represent just one way companies find themselves with inactive plan participants. Other scenarios: If an employer acquires a 401(k) plan through a merger or acquisition, or has high or steady turnover, the number of inactive accounts can become significant. Plan sponsors may not even be aware of how many small accounts have accumulated.

As automatic 401(k) plan enrollment becomes more common, the number of small account balances will likely grow substantially unless plan sponsors add automatic rollover or cash-out features to their plans.

Nevertheless, a significant number of plan sponsors still have not adopted automatic rollover provisions. For the Profit Sharing/401k Council of America's 401(k) and Profit Sharing Plan Eligibility Survey 2010, researchers looked at 931 plans with 8.6 million participants and more than $628 billion in assets. They found that 53.4 percent of all plans automatically roll over account balances of departing employees when those balances are between $1,000 and $5,000, and cash out balances of $1,000 or less.

Of course, some plan sponsors specifically choose not to allow automatic rollovers from their 401(k) plans. In some cases, this approach is driven by the realization—particularly among sponsors of larger plans—that the remaining assets in the 401(k) plan will be invested in institutionally priced funds while most IRA assets will be invested in retail funds. These plan sponsors recognize that a rollover often involves moving assets from an employer's plan with very low-fee institutional funds to an account with higher-cost retail investments. This can make retirement investing more expensive for departing employees than if they had been able to leave their money in the former employer's plan.

Other plan sponsors take a laissez-faire approach to plan administration. "Some plan sponsors don't offer rollovers because they want to let the participant himself decide how to handle those assets," says Robert Liberto, senior vice president with Segal Advisers in New York.

Rolling Over, Reducing Costs

The decision whether to begin allowing automatic balance rollovers for departing employees often depends on a company's circumstances. For example, maintaining the status quo for terminated 401(k) plan participants was not an option for Seattle-based Geonerco Management. Before the recession, the real estate developer maintained operations in five states and a workforce of about 200. Since 2008, however, the company has laid off about 80 percent of its workforce and shuttered operations in two states.

Maintaining a Safe Harbor Automatic rollovers, permitted since 2005, require some regulatory diligence. Specifically, plan sponsors must understand what they need to do to make sure these rollovers are covered under the U.S. Department of Labor's safe harbor provisions. In general, safe harbor rollovers must satisfy six conditions: Plans can automatically roll over distributions between $1,000 and $5,000. The rollover must be made to an individual retirement account (IRA) or annuity offered by a state or federally regulated bank or savings association where accounts are FDIC-insured, an insurance company whose products are protected by a state guaranty association, a mutual fund company, or another financial institution eligible to offer IRAs under U.S. Treasury Department regulations. The written agreement with the IRA provider must specify how the rolled-over funds will be invested and the amount of any fees and expenses. Rolled-over funds must be invested in a way that will preserve principal and provide a reasonable rate of return. Options include money market funds maintained by registered investment companies, interest-bearing savings accounts and certificates of deposit, and stable value products. The fees and expenses charged by the IRA provider cannot exceed the fees charged for other IRA accounts. These fees include maintenance fees, investment expenses, termination costs and surrender charges. Before the rollover takes place, plan participants must receive a Summary Plan Description or a Summary of Material Modifications that explains how rollovers will be invested and any fees charged to the participant. The safe harbor is not available if a 401(k) plan fiduciary undertakes a "prohibited transaction" under the Employee Retirement Income Security Act—for example, by receiving some type of financial consideration from the chosen IRA provider.

These layoffs left the company's 401(k) plans with a large number of inactive participants. The company had long maintained two 401(k) plans—an older plan that was no longer accepting contributions and a newer plan that took over when the older plan went dormant. At one point, the number of participants who had left assets in one of the plans but were no longer working for the company represented about half the total participants in both plans.

For a company reeling from the bad economy and real estate marketplace, having that many terminated employees maintaining 401(k) account balances was a drain in per-participant plan fees—and on the human resource staff needed to track inactive participants.

"Every dollar counts," says Greg Szymanski, SPHR, director of human resources.

To deal with this issue, the company closed its inactive 401(k) plan and rolled account balances of more than $5,000 into the active plan. At the same time, the company amended its active plan to allow for automatic rollovers. This way, individuals no longer with the company who had balances of $1,000 or less were cashed out and accounts with balances of between $1,000 and $5,000 were automatically rolled into IRAs unless participants took action to move the money.

"We gave participants 90 days' notice of the rollovers," says Szymanski. "Having the automatic rollover in place was easier, and the record keeper handled the transactions and necessary notifications." He found that simply sending letters telling terminated participants about the rollovers often spurred people to take action. He estimates that two-thirds of the inactive participants took action before the rollovers happened.

Although the company had to pay for a private investigator and other search services to find "lost" participants, Szymanski notes that the effort was worth it: The number of terminated participants in the remaining 401(k) plan was reduced from 160 to less than 30. The 401(k) plan now has reduced per-participant fees and has shrunk to the point that it is considered a small plan for testing and tax-recording purposes. That means Geonerco is no longer required to hire accountants to conduct independent audits, saving the $10,000 annual expense.

Moreover, having a much smaller number of terminated participants has significantly reduced the time spent on plan administration. For example, notifications of plan amendments and summary annual reports are simpler because there are fewer inactive participants to track down. This is important in a smaller company that does not maintain dedicated resources for plan administration. Szymanski says he no longer has "to spend time worrying about people who are not here."

The author is a New Jersey-based business and financial writer.