Expanding your automatic rollover IRA program
What is an automatic rollover IRA?
Typically, employers have a provision in their workplace retirement plans that allows them to remove former employees with balances of $5,000 or less from their retirement plan. (The threshold will increase to $7,000 effective January 1, 2024.) This provision helps to reduce employers’ costs and administrative burdens.
Former plan participants receive a notice from their employer about this mandatory cash-out and can choose where to move the balance. If a former employee doesn't respond, the employer will roll over their balance to an individual retirement account (IRA) at a qualified custodian.
This new account is called an automatic rollover IRA and is portable. When an account is portable, the former employee has many choices, such as keeping the account with the same provider or transferring the funds to another IRA provider or a current employer's 401(k) plan (if permitted by the current employer’s plan) at any time.
Why do plan sponsors use automatic rollover IRAs?
Plan sponsors use automatic rollover IRAs to help reduce administrative burdens and costs associated with maintaining accounts for former employees who have small balances in their employer-sponsored retirement plans. Automatic rollover IRAs also provide a simple, streamlined process for former employees to keep building their retirement savings, even after they leave their job.
Preventing retirement plan leakage
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.
Currently, employers can cash-out of former employees’ retirement accounts for balances up to $5,000. Under SECURE 2.0, the threshold will increase to $7,000 effective January 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.
SECURE 2.0’s change to the automatic rollover IRA threshold means that plan sponsors will need to look at their current retirement plan documents and adjust their provisions. In addition to increasing their auto rollover maximum balance threshold, plan sponsors can lower 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.
How to expand your automatic rollover IRA program
If you have an automatic rollover service in place, you may need to amend your plan document to reflect the new SECURE 2.0 threshold. As you make this update, you have an opportunity to include all balances up to $7,000 in your auto rollover program.
We’ve provided some sample language for illustrative purposes.
Millennium Trust Company’s Automatic Rollover IRA helps plan sponsors reduce costs and potential liabilities while empowering your former participants. Learn more about our comprehensive automatic rollover solution.
The material in this Blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Millennium Trust Company performs the duties of a directed custodian, and as such does not offer or sell investments or provide investment, legal, or tax advice.