As defined contribution (DC) plans have started dominating the private sector retirement plan landscape, providers and plan sponsors have become more interested in the distribution decisions of older participants when they stop working. These decisions can help address a key question, according to “Retirement Distribution Decisions Among DC Plan Participants,” a paper from the Vanguard Center for Retirement Research.
Should retirement income programs designed to help participants translate account balances into income streams be offered within qualified retirement plans? Or is the individual retirement account (IRA) rollover marketplace the likelier destination for plan assets in retirement?
One interesting statistic in the paper shows plan participants just don’t stay in the plan, says Jean Young, senior research analyst at Vanguard’s Center for Retirement Research and a co-author of the paper. People who are of retirement age, somewhere between three and five years after they have left a company, tend to take their assets out of the plan. Fewer than 5% of participants make use of in-plan installment options.
“We don’t know exactly why,” Young tells PLANADVISER. She suggests a few reasons people move assets into an IRA. They could be doing more holistic planning, she points out, and some people have multiple retirement accounts from multiple employers and want to consolidate their assets. “People are simplifying the structure,” Young says. “Most people will sit down [at that time] and do some planning on their own or with a professional.”
The rising importance of lump-sum distributions mean that participants will need assistance in translating these pools of savings into a regular income stream, the paper contends. Based on current retirement-age participant behavior, most of these retirement income decisions will be made in the IRA marketplace, not within employer sponsored qualified plans, although this may evolve gradually with the growing incidence of in-plan payout structures. One way sponsors might encourage greater use of in-plan distributions is by eliminating rules that preclude partial ad hoc distributions from accounts.
Retirees Need a Plan
A single retirement plan account is not the total picture of what most people have for retirement resources, and the spend-down phase is unique for each person, Young points out. “That account doesn’t reflect the entire household situation, which might include other accounts, as well as the assets of a spouse or partner. The role for plan sponsors and advisers is to provide the tools and the education to assist individuals in figuring this out,” Young says.
The one standard, Young says, is the need for an inflation-adjusted annuity stream to cover living expenses, which requires people to sort through assets and accounts, and make a plan.
Research shows that participants who have made a financial plan previously are in better shape than those that have not, Young says. “We see that people who have started to plan in their 30s and 40s are better prepared,” she says. “A third of individuals are doing the right thing; another third make a reasonable adjustment to get there. And a third are relying on Social Security and tend to have had lower wages throughout their careers.”
Examining how participants decide to leave an employer’s plan after separating and when they begin taking distributions can help plan sponsors decide whether to go “to” or “through” in target-date funds (TDFs). The former suggests a more conservative glide path, assuming assets are used immediately upon retirement. The latter points to an investment strategy that recognizes that assets are generally preserved for several years post-retirement.
Since the assets are not being used for several years, the research shows, people have a longer time horizon. To preserve assets through retirement, the equity allocation is 50% at the year of retirement, and between the ages of 65 and 72 it goes down to a final equity allocation of 30%. “You invest to retain assets longer,” Young says, “so that suggests a ‘through’ approach instead of a ‘to.’ “
Market Not a Motivator
Young emphasizes that the research includes older participants who terminated service in 2008 and 2009, years marked by a global financial crisis and a severe decline in stock prices. Surprisingly, the behavior of retirement-age participants was similar to that of both earlier- and later-year groups.
Other findings from the paper are:
- Preservation of assets. Seven in 10 retirement-age participants (those age 60 and older terminating from a DC plan) preserved their savings in a tax-deferred account after five calendar years. In total, 9 in 10 retirement dollars are preserved, either in an IRA or employer plan account.
- Cash-out of smaller balances. The three in 10 retirement-age participants who cashed out from their employer plan over five years typically hold smaller balances. The average amount cashed out is approximately $20,000, whereas participants preserving assets have average balances ranging from $150,000 to $225,000, depending on the year of termination cohort.
- In-plan behavior. Only about one-fifth of retirement-age participants and one-fifth of assets remain in the employer plan after five calendar years following the year of termination. In other words, most retirement-age participants and their plan assets leave the employer-sponsored qualified plan system over time. Only 10% of plans allow terminated participants to take ad hoc partial distributions. However, about 50% more participants and assets remain in the employer plan when ad hoc partial distributions are allowed.
Young says she finds it a little surprising that more individuals don’t stay in the plan and take advantage of the lower cost of investments negotiated by employers compared with the prices they pay as direct retail investors. Some people want to simplify their financial lives, she says, or some people do not understand the expense structure of how they pay for investments. “I guess it’s a knowledge gap,” she says.
The data in the analysis is from Vanguard’s DC recordkeeping clients over the period January 1, 2004, through December 31, 2012. Analysts examined the plan distribution behavior of 266,900 participants age 60 and older who terminated employment in calendar years 2004 through 2011. The average account balance of participants ranged from $106,800 to $149,400, depending on the year of termination. About half the participants had account balances under $50,000, depending on the year of termination. Three in 10 retirement-age participants had worked for the plan sponsor fewer than 10 years, a factor affecting the number of smaller balances, since account balances rise with tenure. About 45% of retirement-age participants had 20 years or more of job tenure. These longer-tenured participants had average account balances of about $190,000.
“Retirement Distribution Decisions Among DC Plan Participants” can be downloaded from the Vanguard Center for Retirement Research website.