Labor Department rightly trying to plug pension portability leaks

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Sep. 17, 1996: I’m standing in the Oval Office with President Clinton, Treasury Secretary Bob Rubin (my boss), the Office of Management and Budget director, Council of Economic Advisors chair, half the cabinet and a select group of prominent White House correspondents, trying to wrap my mind around three curious facts:

1. This high-powered press event in the Oval Office was convened solely to celebrate a technical Treasury/IRS proposed regulation amendment and ruling my staff and I had just released regarding … “pension portability”;

2. I was the only one in the room who fully understood what we were talking about; and

3. I was the only one in the room who failed to understand why fact No. 2 evidently didn’t matter in the least.

{mosads}What led to that moment was a bit of a dust-up I’d previously had with a self-assured young presidential aide concerned about improving “pension portability” (essentially the ability to take your retirement savings with you and keep them growing while moving from one job to another, or to self-employment or unemployment).

As Treasury’s senior pension expert, I thought I knew more about retirement policy than some upstart White House staffer did. Improving pension portability was desirable, but hardly one of the four or five top issues in pension reform.

Who was he to insist that Treasury set aside our pension policy priorities in favor of immediate action to expand portability?

What I, in my policy geekiness, had failed to grasp — and what that aide, none other than Rahm Emanuel, knew — was the primacy of politics and the curious power of “pension portability” to command attention in Congress and the media (even among some for whom pension issues generally seemed complex and forbidding).

Maybe the answer is that portability is an aspect of this otherwise complex subject that is easy for most of us to relate to. In any event, Emanuel proved to be right, as usual, and we did as he urged. (A decade later, when he was in Congress, we would work together on pension legislation.)

In the 22 years since that Oval Office event, not much has changed: The decades-long quest for improved pension portability remains a challenge. But last week, the Department of Labor issued further guidance to help address it.

Say you’ve just changed jobs and hope to shift your savings from your former employer’s 401(k) plan to your new employer’s plan. Good luck with that.

The problem is not any legal prohibition on such transfers (tax-free “rollovers”) between 401(k)s, other plans and individual retirement accounts (IRAs), because lawmakers and pension regulators often are not the ones actually calling the shots for the private pension system.

Often, those who really lay down the law governing your 401(k) and IRA are the asset managers and recordkeeping firms.

Although it’s not right, if they decide, given their interests, to make it slow and painful to transfer an individual’s savings out of an IRA or into a plan, many individuals will eventually give up on the transfer out of frustration. And of course if the recordkeepers’ IT people say something’s not happening, it’s definitely not happening.

In short, control of your retirement savings is largely in the hands of for-profit recordkeepers and asset managers, competing for assets to manage and subject to cost efficiency targets and administrative constraints.

What you think of as your nest egg, they view as their assets under management (AUM). And asset managers’ business strategy is naturally driven by a large dose of what one might call “AUMphasis” — a powerful focus on maximizing AUM.

As evidenced by the aggressive marketing of plan-to-IRA rollovers, the interests of those who compete for AUM don’t always align with those of savers who own the assets.

This is not to say you can never take your savings with you from job to job. But it’s harder than you’d think because you’ll need to do so, if at all, mainly on their terms. In general, many recordkeepers and asset managers are directionally in favor of pension portability. They favor it when the funds flow in their direction.

That is, unless the amount you want to keep or transfer to a new employer’s plan is too small to manage profitably. Then the magnetic field reverses course: Many recordkeepers and their plan sponsor clients have little interest in caretaking a former employee’s $1,000 or $2,000 balance.

Therefore, for years, when employees left, plans would force out small balances (this was permitted for amounts up to $5,000), sending a check to the employee’s last known address. Once out of the plan, small savings are typically spent (“leakage,” in pension parlance) rather than continuing to be saved and accumulating tax-free for retirement.

In 2001, to limit leakage, my Treasury Department colleagues and I proposed, and Congress passed, legislation to ban these forced cashouts. Instead, unless departing employees direct otherwise, former employers have two choices: Keep the funds in their plan or transfer them to an IRA established for the individual’s benefit.

We sought to promote portability and curb leakage by replacing forced cashouts with these “automatic rollovers” to IRAs (our system’s most portable retirement vehicle). The IRAs serve as a tax-favored parking lot for savings that former employees might later decide to consolidate in a new employer’s plan.

We also hoped the establishment of IRAs for millions of former employees would help move us eventually toward a system in which nearly every American owns a tax-favored retirement saving account.

But, unexpectedly, Labor Department safe-harbor rules provided for these automatic rollover IRAs to be invested solely in capital-preservation money market funds or certificates of deposits. In our low-interest-rate environment of recent years, many of these IRAs have dwindled as administrative costs exceeded earnings.

Enter Spencer Williams and Tom Johnson. These entrepreneurs have designed a system (the “Retirement Clearinghouse”) that builds on and would largely complete the existing automatic rollover regime.

For a fee, the new system collects and matches data on individuals and automatically transfers their savings from their former employer’s plan to an IRA and, in particular, from the IRA to a new employer’s plan (unless the individual directs otherwise).

{mossecondads}Often, though not always, savers are better off in an employer plan than in an IRA because plan fees may be lower and because of fiduciary protections, professional selection of investment options, economies of scale, bargaining power, etc.

Last week, the Labor Department issued for public comment its proposal to approve these “auto-portability” arrangements for amounts up to $5,000. If they work, they should encourage consolidation of multiple small retirement accounts, eliminating multiple fees, reducing leakage and making it easier for individuals to manage their savings.

However, success will depend on the willingness of recordkeepers and their plan sponsor clients to share participant data with the clearinghouse. It will also depend on recordkeepers’ willingness to transcend competitive pressures and cooperate so participants can enjoy expanded portability — first, for small savings, and later, for all savings.

Mark Iwry is a nonresident senior fellow in economic studies at The Brookings Institution. He also is a visiting scholar at the Wharton School of the University of Pennsylvania. He served from 2009 to January 2017 as senior advisor to the secretary of the Treasury.

Tags 401 economy Employee Retirement Income Security Act Finance Individual retirement account Individual Retirement Accounts Money Pension Retirement Retirement plans in the United States Retirement savings account

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