Might it make sense to omit a cash-out provision?

[Peter Gulia]

In some volunteer work for a charity designing a new retirement plan, here’s a question I’m thinking about.

Assumptions

The plan’s investment alternatives are Vanguard and other managers’ mutual funds, with superior share classes obtained through the (independent) recordkeeper’s and its custodian’s omnibus purchasing power. None of the funds pays over any revenue-sharing or other indirect compensation.

The employer pays nothing toward plan-administration expenses. (The charity’s executive director and board chairperson both tell me they can’t get grants or fundraise for any contribution to, or expense of, a retirement plan, and can’t budget for either.) So, all expenses are charged to individuals’ accounts.

The absence of an involuntary cash-out provision won’t risk putting the participant count near the number that would invoke a CPA’s audit of the plan’s financial statements. That’s so for at least the next few years.

Beyond maintaining former employees’ goodwill (which the charity cares about), does such an employer have its own economic stake about whether low-balance participants involuntarily exit the plan, or may, by choice, remain in the plan? Are there factors I’m not thinking about?

For a participant who has only her $3,000 account, which is better: Staying in the former employer’s plan, or choosing a rollover into an IRA? (To simplify the comparison, assume the individual has no next employer, or the next employer has no retirement plan.) Is the individual’s choice as simple (mostly) as comparing the account charge under the former employer’s plan to the account charge of the IRA the individual could or would buy? Or are there more factors to consider?

Your thoughts?

[Bird]

2 hours ago, Peter Gulia said:

Beyond maintaining former employees’ goodwill (which the charity cares about), does such an employer have its own economic stake about whether low-balance participants involuntarily exit the plan, or may, by choice, remain in the plan? Are there factors I’m not thinking about?

I don't see that it matters.

2 hours ago, Peter Gulia said:

Is the individual’s choice as simple (mostly) as comparing the account charge under the former employer’s plan to the account charge of the IRA the individual could or would buy? Or are there more factors to consider?

Yes, if by "account charge" you mean "total expenses" - for the same fund.  There are actually funds with low expenses that can be crappier than funds with higher expenses.

[Peter Gulia]

Bird, thank you for your nice help.

Others with further thoughts?

[CuseFan]

Peter, here are my thoughts:

The employer has no economic stake in deciding whether to have or not have a cash out provision as all expenses are borne by the plan and trying to keep headcount below audit threshold is not a current concern in minimizing employee expense either, so the decision is one solely impacting participants.

Reasons not to cash out: from the employee's perspective, smaller balances may be more difficult to invest similarly in institutional (or other favorable) share classes, etc., subject to minimums that may or may be attainable, subject to higher fees as noted, and maybe there are better (creditor) protections in a qualified plan compared to an IRA in their particular state. On the employer's (paternalistic) side, a cash out provision could lead to more retirement funds leakage with many former employees simply taking their cash outs and spending them rather than rolling into other retirement funds.

The flip side is maybe the terminating employee wants some investment flexibility to choose specific stocks or funds not available in the plan and/or convert to Roth. Assuming there is a voluntary option for terminated employees to get distributions, those who wants their funds for these reasons can get them, so no need to cash out.

All that said, I think the biggest reason to consider cash outs is the missing participant problem as employers and former employees lose track of each other over the years, and the smaller the balance the more likely that happens.

[Peter Gulia]

CuseFan, thank you for your thoughtful observations, especially about using some low-balance cash-out as a way to avoid address-change work.

About keeping up with address changes, some of those burdens and methods follow characteristics of the employee population, including how tech-savvy or even digital-native they are; how much the plan uses email addresses, preferably neutral email addresses not of any employer; and how capable the recordkeeper is in using services to find and fill-in updated addresses.

[CuseFan]

22 hours ago, Peter Gulia said:

keeping up with address changes

agreed - and probably a lessening issue as industry technology improves and this continues as in increasing focus for DOL and IRS and hence (hopefully) plan sponsors.