The flip side to auto 401(k) design: Forgotten accounts

Automatic enrollment has been credited with dramatically increasing 401(k) savings, but new research hints at a major drawback — some workers forget about accounts with small balances later in life.

An academic study posted this month on the Social Science Research Network found that about $790 million in IRA assets were in limbo in 2017, with account owners who are 72½ or older failing to take required minimum distributions. The median amount in those forgotten accounts was $5,400, according to the paper, authored by Lucas Goodman, a financial economist at the Treasury; Anita Mukherjee, assistant professor of risk and insurance at the Wisconsin School of Business; and Shanthi Ramnath, senior economist at the Federal Reserve Bank of Chicago.

“Plan participants who are defaulted into saving have been shown to have lower financial literacy, and therefore are especially at risk for abandoning accounts,” the authors wrote. “Our results suggest this to be the case.”

The authors analyzed data from IRS records and state unclaimed property records.

They found that at age 72½, 2.7% of people had abandoned accounts in 2017. What ultimately happens to those assets is unclear.

“Nearly all of these funds remain with plans and are not sent to state unclaimed property,” the authors wrote. “Regression discontinuity estimates show that abandonment is 10 times higher in automatic rollover IRAs, a type of default account.”

By design, 401(k)s often have policies that roll former employees’ balances into individual retirement accounts if their accounts are small and they do not initiate a rollover on their own after ceasing employment.

The results give a clearer view into the problem of forgotten 401(k)s and IRAs, something that lawmakers for years have been trying to address through a proposed lost-and-found system that would match owners with their accounts. Implicit in the findings is the question of how successful a system that has turned non-savers into savers through automatic enrollment is, if a considerable amount of assets end up never being used.

A heavily publicized report earlier this month from startup firm Capitalize pegged the size of forgotten retirement accounts at $1.35 trillion, although that figure is based on an estimate of all accounts left at former employers — many of which could have been left intentionally and likely are not abandoned.

However, researchers and policy makers tend to agree that the transitory nature of employment is problematic for automatic enrollment, as people increasingly work for many different companies during their lives and as a result might have numerous 401(k)s and IRAs by the time they retire.

The smaller those accounts are, the more likely people are to forget about them, the authors of the recent paper found. But even at account balances of $10,000, about 3% are abandoned. About 61% of assets in IRAs that hold at least $3,000 and are identified as abandoned are reclaimed by owners or beneficiaries after 10 years, the authors noted.

“Holding account balance fixed, we find that measures of financial sophistication observable in the tax data — filing a tax return, earning capital income and paying estimated tax — are negatively correlated with abandonment, as expected,” the report noted. “Our analyses also reveal that abandonment is positively correlated with the non-white share of the population within a ZIP code, even after controlling for education, income and population density.”

The findings will likely give Congress more to consider in addressing the issue.

“Current policy to mitigate abandonment is focused on the use of escheatment to unclaimed property. Yet plan participation is mostly voluntary, and most accounts are neither escheated nor reclaimed upon escheatment,” the authors wrote. “Taken together, our results demonstrate that retirement account abandonment is a timely topic of increasing policy attention – our estimated annual flow of $790 million from IRAs alone is substantial.”