A controversial study suggests too many people are leaving behind their 401(k) accounts when they quit their jobs. The white paper, which was panned by industry professionals, claims these “forgotten” accounts total more than $1.65 trillion in assets.
While the headline numbers may be deceptive, the concept of “orphan” 401(k) accounts is not new. Does it rise to the level of a crisis? That’s a different debate. Does it concern you? That’s the more important question.
There are good reasons and bad reasons for leaving your money in your former employer’s retirement plan. If you have 401(k) accounts scattered in various plans that chart the progress of your career, you are not alone. But don’t expect your old company to come looking for you if you’ve changed your address. They probably figure you know what you’re doing. They won’t bother to contact you, other than sending you periodic statements, until you’re well into retirement.
“Many 401(k) participants are not financially savvy enough to know how to set up an IRA or have a financial adviser that they can work with to assist them not only with the transfer of the assets but with the investment of those assets,” says Joni L. Jennings, Chief Compliance Officer (Retirement Services) and ERISA Compliance Manager (Retirement Services) at Newfront in San Francisco. “For some, it is just ‘easier’ to leave it where it is than to have to spend the time moving the account. It still blows my mind that any employee would just leave money behind, but we see it happen all of the time in this business. Depending on the industry, we also see foreign employees who move back to their home country who may have been auto-enrolled that do not realize they have an account balance in the plan. For account balances over the mandatory cash-out threshold ($5,000 currently but going up to $7,000 under SECURE 2.0), those accounts are not typically identified as ‘forgotten’ until there is a death or required minimum distribution that the plan must make and suddenly the plan sponsor realizes that the former employee is nowhere to be found.”
Not everybody “forgets” about their retirement account. For some, they’ve made a conscious decision to keep their money where it is.
“Why would I remove a lifetime of savings from a plan designed to serve as a lifetime financial instrument—given the fiduciary and bankruptcy and other protections?” says Jack Towarnicky, Of Counsel at Koehler Fitzgerald, LLC in Powell, Ohio. “Why remove assets from a plan where there are tens of thousands of others who have savings in that plan … active employees, term vested participants, retired participants receiving payouts, surviving spouses and other beneficiaries—all who serve as sentinels.”
And that’s an important distinction between “forgotten” 401 (k) accounts and orphan 401(k) accounts. In the former case, the ex-employee owner no longer pays attention to the account. They truly have forgotten about it. In the latter case, participants have decided they don’t have what it takes to house the accounts themselves. As a result, they keep their money in an “orphanage” because they know it will be taken care of. At least until they’re confident they can find a better home for that money.
“Each participant should make an affirmative decision on what to do with accumulated savings once qualifying employment ends,” says Towarnicky. “Where the account balance is greater than $5,000 (soon to be $7,000), assets should remain in the plan until the participant makes an affirmative (hopefully informed) election. While those assets remain in the plan, a good plan design allows the participants to make all of the same choices and decisions they had (and more) while they were eligible to contribute. A great plan design would allow the participant to use the account, if they chose to do so, as an aggregator of retirement savings, as an option to consolidate accounts, with an eye on maximizing protection and minimizing expense.”
That same controversial report that says there’s so much “forgotten” money also claims there’s been a 20% increase in these types of accounts (without identifying how many of those accounts people purposely left in the old plan).
“The 20% increase in so-called forgotten accounts is misleading because it doesn’t distinguish between an account intentionally left behind and a truly forgotten account,” says Peter Nerone, Compliance Officer at MM Ascend Life Investor Services, LLC in Cincinnati. “I do not doubt the 20% increase in the combined category. I believe the added DOL rules make it more likely that somebody with a small balance would not receive adequate professional assistance. That’s the unfortunate reality of making it too much of a burden on the professionals to justify working with small accounts.”
In addition, the report says the increase occurred because of post-Covid job switching. Even if you believe the 20% number, there may be other reasons for it.
“Some surveys show that more plan sponsors are focused on asset retention today, allowing individuals to retain assets in the plan after separation,” says Towarnicky. “But, more importantly, the 20% increase may be a function of more individuals having in excess of $5,000 in their accounts, and, perhaps a change in employment perspective prompted by the pandemic: 1) For involuntary terminations of younger workers, the pandemic response by the federal government likely prompted some to take more time in their search for a new position, and 2) For involuntary terminations of older workers, studies show a much larger percentage have not (yet) returned to the workforce.”
In addition, the very advances in plan design, so successful in getting more people to save for retirement, may cause them to pay less attention to their 401(k) plan. This could lead them to “forget” about it after they’ve left the employer that sponsors that plan.
“These ‘forgotten accounts’ are a consequence of the systemic growth of retirement disengagement strategies,” says Mark Nicholas, founder of Transform Retirement in Green Bay, Wisconsin. “Automatic enrollment, automatic escalation, default investments, and now automatic portability initiatives all contribute to workers being less engaged with their savings. When the solutions put in front of workers are designed to run on autopilot, we shouldn’t be surprised by terminated employees’ continued disengagement.”
Still, inertia alone may not be responsible for more money from separated participants staying in the 401(k) plan.
“Very few workers know how to move their money once their employment changes,” says Nicholas. “They’re also faced with the challenge of trying to figure out the best place for them to move it to, which can feel overwhelming for many workers. Also, plan service providers often have asset-based fees creating a financial disincentive to help terminated participants make prudent decisions.”
Sure, it’s OK for you to leave your retirement savings in a former employer’s 401(k) plan. There’s nothing wrong with that, if you have good reasons. If you find yourself job hopping, though, this could cause your orphan 401 (k) to be dispersed across a wide array of past employers. Ironically, this may make the job of managing your retirement money more difficult.
“There is likely some truth to the forgotten accounts, but just because the accounts have not been rolled over into an IRA, another 401(k) plan or cashed out does not mean that the accounts are completely forgotten,” says Jennings. “I do believe that there are employees who opt to leave the accounts in their former employer’s plan for many reasons. Is that wise? Probably not, because I do agree that not having all of the retirement funds under one umbrella may skew the asset allocations and diversification applicable to that employee. Many service providers offer rebalancing but would not know about all the investments, which may cause an unbalanced allocation based on the employee’s age to retirement. Maybe I am hopefully optimistic that a person with $56k sitting in a retirement account would not forget that it is there, especially if the plan is meeting all of the required statement and notice delivery.”
What’s the best option for you, and how do you determine whether to take or leave your 401(k) account when you switch jobs? That’s a question answered in the next article in this series.