What Is an Automatic Rollover?
1. Automatic rollover is the transfer of a qualified retirement plan distribution into an individual retirement account with no action required by the account holder. This happens when a company removes an employee with a small balance from a company-sponsored retirement plan after they leave the company. Employees with larger balances have the option of remaining in the plan.
2. Automatic rollover also refers to the reinvestment of interest and principal from a certificate of deposit upon its maturity with no action required by the account holder. When a CD matures, the certificate holder has a certain number of days to move the proceeds to another account. If they do nothing, the financial institution automatically reinvests the proceeds into a new CD with the same maturity as the original CD.
Understanding the Automatic Rollover
1. Automatic rollover is part of the Safe Harbor rules, which require companies to give affected employees required disclosures, instructions for how to reinvest, as much as 60 days notice that they will be removed from a retirement plan. Once this notice period elapses, employees’ funds go into another investment vehicle called a Safe Harbor IRA that invests in a money market fund or another low-risk investment. If the plan holder wants something different to happen, other options include a cash distribution or a rollover to a specific retirement account. Safe Harbor IRA rules became effective in 2005, as part of the 2001 Economic Growth and Tax Relief Reconciliation Act.
2. Automatic rollover, also called "automatic renewal," almost always reinvests in a CD with the same term as the original investment. However, the interest rate often is different, depending on current yields.
Pros and Cons of Automatic Rollover
1. Automatic rollover helps companies remove small-balance accounts from 401k and other retirement plans. Having too many small accounts is both an administrative burden and an added expense. Removing a large number of small accounts helps to reduce costs for others in the plan. The drawback for employees that do not take action is that their retirement savings will not keep up with inflation if they are automatically left in a low-yielding investment for many years.
2. Automatic renewal can simplify the reinvestment process for CD holders. Consider an investor in one-month CDs. Without automatic renewal, this investor needs to shop for a new CD each and every month if they want to stay invested. One drawback for holders of longer-term CDs, however, is this type of investor might prefer to put the funds into something else, and if they do not act in the few days before an automatic rollover kicks in, they face a penalty to cash out the new CD early. Additionally, automatic renewal can sometimes put investors in lower-yielding CDs at unfavorable rates.