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How advisers can help 401(k) clients with auto-rollovers

Advisers can add a lot of value by instituting a program to rid a 401(k) plan of small account balances

Jan 23, 2019 @ 11:01 am

By Blaine Aikin

Retirement advisers looking to make positive changes in 2019 should resolve to help 401(k) clients arrange for mandatory distributions to rollover IRAs.

Advisers can help plan sponsors trim their administrative costs, reduce fiduciary risks and provide potential wealth benefits to former plan participants by instituting a process to automatically distribute small account balances of departing employees into individual retirement accounts.

Telling the auto-IRA story is straightforward. It starts with a simple acknowledgement that plan distributions can create real headaches. Terminated employees with low retirement-plan balances don't often give much thought to what they should do with the 401(k) money they left behind.

If the participant doesn't act and there isn't a provision in the 401(k) plan mandating a distribution, that money stays in the plan. It may impose unnecessary administrative burdens and costs on the plan sponsor.

Or, if those costs are paid from plan assets, current employees effectively end up subsidizing the costs of maintaining the accounts of terminated employees.

(More: Millennials are a growth engine for 401(k) advisers)

Rules allow sponsors to mandate distributions of $5,000 or less to IRAs for employees who are leaving the company and do not overtly elect other distribution options, such as cashing out, transferring to the plan of a new employer or directing a rollover to an IRA of the employee's own choosing.

The 401(k) plan document must explicitly provide for mandatory distributions of small balances, and the summary plan description must explain the mandatory distribution and automatic-rollover provisions of the plan. If they don't, the plan document must be amended and the revised SPD must be distributed to participants.

The regulations also allow, but do not require, account balances of up to $1,000 to be automatically cashed out. However, as a practical matter, automatically sending checks to departing employees bypasses the biggest benefits of an auto-IRA approach.

Some recipients may just spend that money, incurring taxes and penalties and divesting from their retirement savings.

Other intended recipients may have moved without providing forwarding instructions or they simply fail to cash their distribution checks promptly. Until a check is cashed, the money remains a plan asset and the sponsor must continue to send required participant disclosures and retains fiduciary responsibility for the account.

When the conversation turns from education to implementation, the adviser can add significant value by helping the plan sponsor select a provider for the automatic-rollover program. The selection is a fiduciary act because plan participants will depend upon the services and investments offered by the selected provider and will not have been involved in the selection of that provider.

(More: How to keep your 401(k) clients out of court)

The DOL has established a fiduciary safe harbor for the provider selection process that has only five requirements. These are far easier to meet than a full-blown service provider selection process. In brief, the five requirements are:

1. The auto-rollover process is for "small balance" accounts only, as described above.

2. The rollover must be to an IRA offered by a IRA custodian of the type authorized by the IRS.

3. The rollover money must be invested in a product that provides safety, liquidity and a reasonable rate of return.

4. The fees and expenses for the account and the investment must be comparable to non-automatic-rollover IRAs.

5. The participant must have the right to enforce the terms of the IRA.

As a baseline criterion for consideration, competing providers should clearly be able to satisfy the safe harbor requirements. The adviser and sponsor should not assume that all providers are the same or that all can satisfy the safe harbor. For example, some record keepers have developed proprietary auto-rollover capabilities or contracted with a preferred provider to offer all their clients.

Keeping in mind that the selection of the provider is a fiduciary act, and the adviser and sponsor should subject the record keeper's default offering to the competitive due diligence process and insist that the record keeper accommodate the provider that best meets the plan's and participants' needs.

Due diligence should compare costs and capabilities. All administrative and investment fees and expenses should be identified and compared to make sure they are fair and reasonable for the plan, the plan sponsor and — most importantly — the plan participants whose accounts will be rolled over.

Capabilities of providers can vary significantly. The default investment must be safe, liquid and pay a competitive return. But the IRA should also offer a lineup of other high-quality investments so that the account holder can make contributions and diversify the holdings to prepare for retirement. Administrative processes should be comprehensive, reliable and highly automated.

The adviser's real value-add is to pick a top-notch provider that will demonstrably improve the way the plan operates and serve both current and former plan participants well. The adviser should stay on top of how the auto-rollover plan is working and whether the provider is delivering services that are at the forefront of what is available in the marketplace.

Scan your plans to look for ones that tend to have high turnover, low balances and terminated employees still in the plan. Targeting those plans is a good place to start. But there's no need to stop there — auto-rollover IRAs can add value across the spectrum of plans.

Blaine F. Aikin is executive chairman of fi360 Inc.

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