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The damaging impact of DC plan failures

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Making it simpler for workers to move money between retirement plans when they change jobs would mend gaping rifts in the retirement savings system that are costly to all parties involved.

The current system is needlessly Byzantine and it does not just impact employees who have their money fall into its cracks. Plan sponsors face increased costs, plan providers lose revenue and policy makers become pressured to consider regulatory patches in an effort to fix breakdowns and address short-comings.

Boston Research Group (BRG) recently published a whitepaper titled: “Eliminating Friction and Leaks in America’s Defined Contribution System” based on a case study of one of the nation’s largest health care providers with more than 200,000 employees and 25 percent annual turnover rate. The company instituted an innovative account consolidation program from 2007-2012 that BRG documented.

The case study and the company’s implementation of an account consolidation program were addressed at a felicitous time. We are living in an age where workers’ unpreparedness for retirement is oft-documented and the devastating impacts that it wreaks on individuals and the economy as a whole is almost covered daily in the news. Offering up any tactic to stop employees from leaving money on the table will pay big dividends.

The “Company Man” was at one point a common occurrence in this country. You started a job out of college or high school and worked your way up over the years. Now, American workers change jobs an average of 7.4 times during a 40-year career, according to the Employee Benefits Research Institute (EBRI). At theses various points of change is where the defined contribution (DC) system fails the employees by not safeguarding them from cashing out and not providing an efficient means for them to manage their retirement savings.

The whitepaper found that during a change of employment, 45 percent of DC participants will cash out their balances even though they face costly penalties. These “drop outs” remove trillions of dollars from America’s retirement savings over time. Statistics show that employees who cash out are usually ones with lower balances and therefore, the ones that need the money the most.

The failure of the DC system is glaring when it comes to job-changers. Since the advent of the Pension Protection Act of 2006, employees have increasingly been enrolled DC plans automatically. However, that hand-holding stops when the employee switches jobs and renders them with no knowledge of the mechanics behind their DC plan because it was all done for them.

“The defined contribution system is very efficient at bringing assets into plan accounts, but is very weak at moving money between accounts,” said Warren Cormier, president of the BRG. “There is a tremendous amount of friction that results from complex rollover procedures and an absence of assistance at the point of job change. The result is too often leakage—participants taking the paths of least resistance by cashing out or leaving their accounts behind with their old employers. The goal is obviously to stop cashouts and keep the dollars either in their next employer’s DC plan, preferably, or in a qualified account such as a low-cost IRA.”

BRG found during the case study that there was a lot of success when the employer utilized Retirement Clearinghouses to assist participants with rollovers and new employer plans. When employees are given access to start-to-finish assistance from impartial counselors:

  • Cashouts were cut in half;
  • There was a reduced number of stranded accounts; and
  • An estimated $6 million in costs were saved.

Plan sponsors were also able to reduce administrative issues, fiduciary tasks and lower plan costs.

Some of the best practices noted in the whitepaper that the company implemented include:

  • Assisted roll-in;
  • Automatic rollover;
  • Assisted rollover; and
  • Annuity, which assists current employees near retirement annuitize some or all of their plan balances.

The simple steps taken by the company in the case study do not place a heavy burden on the plan sponsor or on the individual employee. They make a large impact in addressing the breakdowns in the DC system that foment damaging consequences for all parties involved.