According to the U.S. Census Bureau, nearly half of Americans between the ages of 55 and 66 have $0 in retirement savings. Cashing out retirement savings early, often referred to as retirement or 401(k) leakage, is one of many reasons why people are financially unprepared for retirement.
The law requires cash-outs above $1,000 to be placed in an automatic rollover IRA, unless the former employee elects otherwise. Many employers cash out former employees’ retirement balances of $1,000 or less, removing the former employees’ funds from the retirement system. These former employees, largely through inertia, often do not roll over these smaller balances into an IRA or their next employer’s plan. Not only do these employees miss opportunities for their money to grow, but they may also be hit with a tax penalty.
Additionally, many distribution checks go uncashed, which can increase plan costs, complicate plan administration, and prevent fiduciary responsibilities from being fulfilled.
Instead, plan sponsors can help keep retirement balances of $1,000 or less in the retirement system with an automatic rollover IRA rather than cashing out those retirement accounts, and the good news is that the IRA is still available for balances of $1,000 or less.
SECURE 2.0 and automatic rollover IRAs
The SECURE 2.0 Act of 2022 is a retirement savings law aimed at helping people save more for retirement, providing improvements to existing retirement rules, and lowering the cost for employers to set up retirement plans. This Act contains nearly 100 provisions designed to achieve these goals. One important provision impacts automatic rollover IRAs.
Under SECURE 2.0, the threshold increased from $5,000 to $7,000 on Jan. 1, 2024.
What SECURE 2.0 did not change is that these cash-outs above $1,000 are placed in an automatic rollover IRA if the employee is unresponsive – and even at $1,000 or below, employers can still use an automatic rollover IRA and have fiduciary protection.
Plan sponsors increased their threshold on Jan. 1, 2024, but may not have lowered their minimum balance threshold.
Including all retirement plan balances up to $7,000 in an auto rollover IRA program can decrease retirement plan leakage for former employees while decreasing liability and plan maintenance for plan sponsors.
What happens when a plan sponsor expands their auto rollover IRA program?
– More small balances from former employees remain in the retirement system.
– Former employees who might otherwise spend the funds are nudged to keep them saved for retirement. – Plan sponsors reduce retirement plan costs and administrative burden.
– Retirement plan liabilities are reduced.
