Supreme Court ruling highlights an expansive definition of plan fiduciary

The U.S. Supreme Court, in its Hughes v. Northwestern University ruling, underscored the need for plan sponsors to err on the side of more rather than less when considering the scope of their fiduciary responsibilities. While the case focused on high-cost investment options, it’s conceivable that the ruling could eventually expose plan sponsors to fiduciary risk for decisions that produce unnecessarily high levels of cash-out leakage for terminated participants, a potential risk that could be avoided if plan sponsors were to proactively adopt asset portability solutions, such as auto portability.

The Court’s ruling in Hughes v. Northwestern University makes something very clear. The 8-0 ruling, issued on Jan. 24, mandates that the ability of participants to choose from a selection of inexpensive and higher-cost investment options in defined contribution retirement plans cannot, in and of itself, prevent lawsuits claiming that plan sponsors are in breach of the Employee Retirement Income Security Act’s duty of prudence for fiduciaries. The “fiduciaries” here are, of course, plan sponsors that are in charge of managing defined contribution plans. 

The ruling also left some confusion over the definition of “fiduciary,” and what that role and duty encompass. This is why, in addition to the oversight of investment options in their plans, sponsors should assume they could be held accountable for decisions they make regarding the disposition of accounts from terminated participants. 

Under the Economic Growth and Tax Relief Reconciliation Act of 2001, sponsors were given the opportunity to automatically cash out terminated accounts with less than $1,000, and automatically roll terminated accounts with under $5,000 into safe-harbor IRAs. These “mandatory distributions” can harm participants’ retirement outcomes over the long term because:

• Small accounts with under $1,000 would grow in balance size if they remained invested in the U.S. retirement system.
• If the checks for less than $1,000 are sent to out-of-date mailing addresses in the files of plan recordkeepers, then participants wouldn’t receive their savings, and wouldn’t know they had been cashed out.
• Safe-harbor IRAs can gradually diminish retirement savings in accounts automatically rolled over to them. 
  • The only default investment choices allowed in safe-harbor IRAs are principal-protected products (money market funds). These products have yielded extremely low returns given where interest rates have hovered since the financial crisis of 2008.  
  • Safe-harbor IRAs can also apply high fees, with some charging as much as $50 or more in annual administration, according to publicly available product information. This is well beyond two times the interest earned on a $1,600 account balance, on average, at a yield of 1%. 

Participants who choose to prematurely cash out retirement savings accounts (with taxes and penalties) due to a lack of availability of, or assistance with, plan-to-plan portability when they switch jobs can also reduce their income in retirement:

• According to industry research conducted by Retirement Clearinghouse, LLC, the portability solutions provider where I serve as President and CEO, a hypothetical 30-year-old participant who cashes out a 401(k) account with a balance of less than $5,000 today would forfeit up to $52,000 in earnings they would have accrued by age 65, if we assume the account would have grown at 7% per year. 
• The Center for Retirement Research at Boston College reported in a study that premature cash-outs can, on average, reduce a participant’s overall 401(k) savings for retirement by 25%.

A whopping $92 billion in savings is cashed out of the U.S. retirement system every year, according to the Employee Benefit Research Institute (EBRI). Prior to the COVID-19 pandemic, EBRI estimated that 14.8 million participants switch jobs every year, and data from the largest plan recordkeepers revealed that nearly one-third (31%) of these participants will cash out their 401(k) accounts within one year of joining another employer.

Cash-out rates within a year of job-change are higher than average for workers who are members of minority communities (63% for Black Americans and 57% for Latinos), or earn $20,000 to $30,000 in annual income (50%). 

Historically, the lack of seamless plan-to-plan portability of retirement savings accounts at the point when employees switch jobs has made prematurely cashing out 401(k) accounts, or stranding them in prior-employer plans, the easiest choice for Americans to make during their working lives. The introduction of auto portability has permanently changed that dynamic.

Auto portability was developed to reduce the destructively high level of cash-out leakage from the U.S. retirement system—but it can also help sponsors mitigate fiduciary liability by eliminating mandatory distributions. Auto portability is the routine, standardized, and automated movement of an inactive participant’s retirement savings account with less than $5,000 from a former employer’s retirement plan to an active account in their new employer’s plan. This solution utilizes a “match” algorithm and “locate” technology to find and identify an accountholder of a terminated account, and begin the process of rolling the terminated account balance into an active account in the plan of the participant’s current employer, thereby preserving the participant’s savings and enabling future savings growth. 

Adopting auto portability so that this process can be implemented for participants as they switch jobs can prevent the need for sponsors to automatically cash out terminated accounts with less than $1,000, or automatically roll over accounts with under $5,000. It can also reduce a plan’s incidence of lost and missing participants and uncashed distribution checks. Both of these outcomes can mitigate fiduciary liability for plan sponsors. 

If auto portability is broadly adopted over the course of 40 years, EBRI estimates that up to $2 trillion in additional savings, measured in today’s dollars, would be preserved in the U.S. retirement system—including approximately $191 billion for about 21 million Black Americans, and $619 billion for all minority workers. 

Auto portability is more than just a plug for cash-out leakage. This solution has been live since July 2017. Adopting it as a plan feature takes on a new urgency for sponsors in light of recent lawsuits and court rulings focusing on an expansive definition of their fiduciary duties.  

Spencer Williams is President and CEO of Retirement Clearinghouse, a portability solutions provider. To learn more about auto portability, please visit https://rch1.com/auto-portability.