401(k)s have a ‘portability failure,’ and that’s a problem for employees

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The 401(k) system, introduced in 1978, is showing its age and grappling with significant challenges.

Currently, only about 50% of workers have access to these plans through their employers, and the system wasn’t built to accommodate today’s increasingly mobile workforce, according to Laurie Rowley, co-founder and CEO of Icon, a retirement solutions firm.

This has resulted in major issues with account portability and a troubling number of lost retirement accounts. In a recent episode of Decoding Retirement, Rowley highlighted these shortcomings within the US retirement system.

“The portability failure of the 401(k) plan is because it was never constructed to be portable,” Rowley said. “There’s all these patchwork systems that people can use,” she said, but added that those systems are imperfect.

According to Rowley, when an employee leaves an employer with a 401(k) plan, one of four things typically happens.

Some leave their 401(k) behind. Rowley noted that some 25% of all assets in 401(k) plans are abandoned or lost. That’s 29 million people who have lost their 401(k) plan. “When they walk away from it, they forget where it is,” she said.

Others roll their 401(k) plan into an IRA. About $800 billion has been rolled out of 401(k) plans and into IRAs.

A tiny segment of people choose to roll it into a new employer’s 401(k) plan, but it’s often “a hard thing to roll into another employer’s 401(k) plan,” she said.

In still other cases, the employee cashes out their 401(k).

“That’s the portability failure, in my opinion,” she said. “It’s a lot for us to expect people to make these decisions every time they change jobs about where they’re going to put the retirement plan, what investments they’re going to have. … It’s the most important asset that people have in their life, and we’re asking them to change it every couple of years. That’s where the problem comes in.”

One way retirement account owners can address the “portability” challenge is to roll over their 401(k) into an IRA.

“I absolutely think that every individual should keep their retirement plans with them,” she said. “I think they should take it out of that employer’s plan and put it into an IRA so that they have control of it.”

That way, “they know where it is,” she continued. “They can monitor their investment. They can watch the fees and their portfolio and not be subject to losing their plan … I think people need to keep that asset with them through their whole life.”

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Rowley’s firm offers another solution called the Portable Retirement Plan (PRP). A PRP functions much like a traditional plan, where employees contribute to their accounts through payroll deductions.

“It’s a combination of a workplace retirement plan and an individual plan,” she said. “We know that getting folks to save through their employer is a really good way for people to build their [wealth].”

The key difference is that the PRP eliminates the cost, complexity, and fiduciary responsibility for the employer, making it easier to set up and manage, Rowley said. Under her solution, plans are established on Icon’s platform and Icon assumes the fiduciary responsibility for the individual.

“We can put them into a personalized portfolio that’s tailored to their needs, and their savings go directly into their own account that they own because it’s a form of an IRA,” she said.

This approach, according to Rowley, ensures that when an employee leaves their job, they can take their plan with them, eliminating the need for rollovers.

“You don’t have to change your investments,” she said. “You don’t have to change anything about your plan. You just disconnect from your employer. And you can go on to use your plan at your next employer.”

Each Tuesday, retirement expert and financial educator Robert Powell gives you the tools to plan for your future on Decoding Retirement. You can find more episodes on our video hub or watch on your preferred streaming service.