This Earth Day, We are Reminded to Recycle 401(k) Savings, Instead of Adding to the Landfill of Safe Harbor IRAs

By Spencer Williams | March 13, 2024

On April 22, we will celebrate the 54th annual Earth Day, which gives us the opportunity to celebrate our planet’s natural surroundings and contemplate how we can help preserve them. The advent, and ongoing expansion of recycling programs has enabled our society to reduce our waste—and although there is still quite a long way to go, we have evolved significantly from the post-World War II throwaway culture.

In the U.S. retirement system, we have also experienced a lot of 401(k) asset waste in recent decades. The lack of a seamless process for moving 401(k) savings from one employer’s sponsored plan to another, a highly mobile American workforce, and the expansion of automatic enrollment under the Pension Protection Act of 2006 all came together to create a plethora of small, stranded accounts littered throughout the 401(k) system, as well as an uptick in 401(k) cash-outs.

The Employee Benefit Research Institute (EBRI) estimates that $92 billion in assets leak out of the U.S. retirement system every year, and the organization determined that the cause of the vast amount of this cash-out leakage occurs as a result of plan participants switching jobs.

Under the SECURE 2.0 Act, the balance limit on stranded 401(k) accounts from former participants that plan sponsors are allowed to automatically roll into safe-harbor IRAs was raised from $5,000 to $7,000, as of December 31, 2023. Data from the largest 401(k) plan recordkeepers shows that, historically, 401(k) accounts with balances under the automatic rollover limit are cashed out by participants at much higher rates (on average, 55%) than all 401(k) accounts (on average, 31%) within a year of job-change. In addition, safe harbor IRAs are required to be invested in sub-optimal money market-type of investments, meaning fees are often greater than returns, thereby depleting account balances over time.

Without a solution for altering this trend, the SECURE 2.0 provision runs the risk of expanding the asset waste in the proverbial 401(k) landfill. At Retirement Clearinghouse (RCH), our latest Auto Portability Simulation (APS)—harnessing data from the U.S. Department of Labor as well as EBRI and the largest recordkeepers—found that an estimated 6.7 million participants with under-$7,000 401(k) accounts will change employers this year. But on top of that, on a one-time basis beginning in 2024, our APS estimates that 1.1 million terminated-participant accounts with small balances could instantly become eligible for movement into safe-harbor IRAs.

The 401(k) Recycling Solution

Auto portability—the routine, standardized, and automated movement of an employee’s retirement savings account (now with less than $7,000) from their prior employer’s plan into an active account in their current employer’s plan—was created with assistance and input from the private and public sectors in order to help participants and plans “recycle” their 401(k)s, instead of allowing them to end up in a landfill.

The expansion of this 401(k) recycling solution received a big boost in November 2023, when the Portability Services Network—an industry utility co-founded by the industry’s largest recordkeepers and RCH —went live. PSN’s primary mission is to enable widespread adoption of auto portability.

If PSN’s efforts are successful and auto portability is adopted nationwide, our APS estimates that over the next 40 years cash-out leakage from the U.S. retirement system would decrease by $355 billion.

And, the same scenario would preserve an additional $1.6 trillion in savings in the U.S. retirement system at the end of the 40-year period—including $216 billion in more retirement savings for 30 million Black Americans.

While much still needs to be done, recycling programs and other environmental and sustainability initiatives have done a lot to reduce waste, and raise the awareness of the need to do so. The retirement services industry and plan sponsors have an opportunity to reduce the cashed-out and safe harbor IRA asset waste in the U.S. retirement system.