Why you shouldn’t ‘set and forget’ your retirement accounts

The Social Security Administration recently sent me several letters suggesting that I may be entitled to some retirement benefits from three of my previous employers.

According to the letters, I earned retirement benefits, or what the Social Security Administration (SSA) called “deferred vested benefits,” in jobs covered by my previous employer’s retirement plans. The SSA instructed me to contact the plan administrators to determine whether I already filed a claim and received payment from the plan or not.

Now, I don’t recall filing a claim and receiving payment from those plans. I might have. Then again, the dollar amounts in question are rather small so maybe I didn’t file a claim. Maybe I did abandon those accounts.

Either way, I’ll learn soon enough whether I’m eligible for those retirement benefits or whether I already received payments from those plans.

Meanwhile, I’ve also learned that retirement account abandonment is a big problem, according to Set It and Forget It? Financing Retirement in an Age of Defaults, a working paper recently published by the Federal Reserve Board of Chicago.

According to the paper’s authors, some retirement account owners “abandon” their accounts, and this abandonment is an especially big problem for plan participants who have been automatically enrolled in a 401(k) plan.

Read: How to find your lost 401(k) and other retirement accounts

In their research, the authors documented the number of IRA owners who fail to meet their required minimum distributions (RMDs) continuously for 10 years after they begin, which is considered to be a proxy for abandonment.

They found that among retirement-age IRA owners, roughly 0.4% fail to claim their accounts within 10 years. The median value of an unclaimed account is $5,742 (in 2016 dollars). The aggregate amount unclaimed is thus quite small in the context of IRA balances. “But given the potentially low cost of interventions to reduce this number, however, these accounts remain worthy of policy interest,” the authors wrote.

The authors also analyzed state unclaimed property databases, which are populated with accounts of all types including IRAs and 401(k)s sent to the state (i.e., escheated) by plan custodians who failed to locate the account owners within three to five years of the start of RMDs. According to the authors, escheatment is another proxy for estimated abandonment.

Read: Your 401(k) has had a wild year — how to know when it’s time to rebalance

What’s more, roughly 3.3% of the older population had an abandoned retirement account. Again, the escheated amounts were small in value, but the authors did review the effectiveness of state policies in reuniting what may be abandoned retirement funds with their owners. Wisconsin, for instance, has an automated process to send the funds from escheated accounts to their owners. In Massachusetts, like most other states, account owners must actively engage with the unclaimed property database to retrieve their accounts. Not surprisingly, the policies make a big difference. In Massachusetts, only 3.4% of unclaimed retirement accounts reported in 2016 were claimed within two years, compared with 67% in Wisconsin.

In the third analysis, the authors studied the behavior of individuals induced to engage in an automatic IRA rollover (also known as “forced transfer”) of savings left with a former employer.

As some might recall, an “automatic rollover” policy starting in 2005 allowed accounts of separating employees that had balances between $1,000 and $5,000 to be automatically transferred to an IRA designed to hold the funds until retirement. Not surprisingly, the authors noted, nearly all employers take up this policy option, which allows them to unburden themselves of small accounts, which can bear relatively high administrative costs.

The authors found that those affected by the automatic rollover policy exhibit passive behavior. They were automatically enrolled in a principal-preserving investment plan and didn’t interact with the account over the next 10 years. Plus, they were “substantially less likely to update their address with the plan custodian” and that created a causal link to eventual account neglect or abandonment. Lastly, the authors found those induced by the policy to hold an automatic IRA rollover are 5 percentage points more likely to have missed three years of RMDs.

“I think there’s a fair bit of lack of knowledge around required minimum distributions and retirement account rollovers, both of which contribute to our measured abandonment,” Anita Mukherjee, an assistant professor at the University of Wisconsin-Madison’s School of Business and co-author of the paper, wrote in an email.

People are also having more jobs in their lifetime (the average is now 12, according to the Department of Labor), so there is much more to keep track of, according to Mukherjee.

“We think the abandoned accounts we see represent a mix of people just forgetting about them, people not appreciating how much they have grown over time (so not bothering to claim them), or people not bothering to claim given the many frictions to doing so (have to call old plan managers, have documentation, etc.),” she wrote.

What’s more, Mukherjee also thinks that when accounts are created by default enrollment rules, people may not know about them and may not even think to look for them.

“We find abandonment is much higher in at least one type of auto-enrollment account,” she wrote.

Default benefits outweigh the harm of abandonment

Bonnie Treichel, chief solutions officer at Endeavor Retirement, agrees with the research paper’s authors in stating that “passive behavior in retirement saving, which we connect to potential abandonment later in the lifecycle…such accounts, due to being less salient…are more vulnerable to becoming abandoned.”

Treichel also agrees entirely that when you default people, there are going to be several people that are unengaged and hence, some of those people are likely to result in abandoned accounts. And she further agrees with the other literature cited in the paper that defaulted participants are likely to be those with lower financial literacy.

“All that being said, that isn’t a reason not to default participants because the benefits outweigh the harm of abandonment,” said Treichel. 

Why people abandoned their money

People abandon their retirement accounts because 1) they are unengaged; 2) there isn’t the proper communication to support keeping them engaged during employment and helping them move accounts at termination; 3) retirement is in the future and there is a lack of urgency about staying engaged with something so far away for many participants; and 4) moving accounts is often very difficult for participants—practically speaking, Treichel said.

Among other things, it’s fairly common that record-keepers aren’t incentivized to help participants roll their money out of the plan, she said. 

Consequences of abandonment

What are the consequences when plan participants abandon their retirement accounts?

“When participants abandon their property—even small amounts—they miss out on the power of compounding over time,” said Treichel. “Missing out on a few small accounts in your 20s and 30s can result in large losses to your accumulated account balance by the time you are 65.”

For example, even a small account of $3,000 at a 6% market rate can turn into $17,000 over 30 years, she noted. “If a worker that has a few jobs in their 20s or 30s misses out on these accounts because it goes to a rollover IRA and sits in a money-market account, that is a powerful problem,” said Treichel.

There are two primary problems with force-out IRAs, Treichel noted: 1) fees are too high and will eventually consume the entire account balance and 2) typically the investment is a money-market account that won’t have a rate of return that is meaningful. 

Stopping the trend

What can be done to help avoid the abandonment of retirement accounts?

Policy makers may need to modify how money from IRAs is withdrawn and taxed, the authors said. Defaults into retirement saving plans may require safeguards to prevent forgetting these accounts. And state policies for connecting unclaimed property with their owners could feature greater automation to improve these efforts.

Mukherjee also offered the following solutions:

  • Increase cash-outs at job separation. Generally, according to the IRS, the amounts an individual withdraws from an IRA or retirement plan before reaching age 59½ are called ”early” or ”premature” distributions. Individuals must pay an additional 10% early withdrawal tax unless an exception applies. “We could allow people to cash out some amount without the fee,” she wrote.
  • Let people cash out instead of putting the money in a hard-to-find account by default rules (e.g., automatic enrollment IRAs are like this).
  • Make rolling over retirement accounts easier. “Right now most activity happens right at job separation when people might also be busy moving, etc.,” Mukherjee wrote. “It would be good to encourage a rollover a few months later.”

Treichel also offered three solutions:

  • Engagement while employed.
  • Communication upon termination. “There is a lot of communication required when a participant starts working for a company, but it is not required when a participant leaves,” she said. “In the absence of required communication, it would be helpful to give some information to participants about what happens or could happen when they leave a company.”
  • A centralized place for abandoned accounts across record-keepers. For example, Treichel noted that Fidelity Investments, Vanguard Group and Alight Solutions have started a consortium called Portability Network Services, which is targeted to solve this exact problem and gives participants one place to go instead of calling a bunch of different record-keepers. 

All that could go a long way toward resolving the problem of abandoned retirement accounts. Meanwhile, the Social Security Administration seemingly has our backs when it comes to abandoned retirement accounts.

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