Suggestions for the best way to draw down a 401(k) account are kind of like suggestions about where to find the best slice of pizza.
Stewart Lawrence, senior vice president and national retirement practice leader with The Segal Group, says the subject of drawing down retirement savings is one of the most complex and challenging areas of running a 401(k) plan and managing individuals’ wealth. It’s an area where personal tastes and objectives matter significantly, where a one-size fits all approach doesn’t make much sense.
Even a simplified and well-run 401(k) plan will have a participant population with hugely diverse financial circumstances. As Lawrence puts it, the best drawdown strategy for some may be the worst for others: “Everyone’s situation is different,” he notes, even within a single plan.
Lawrence ticks off just a few of the variables that should help inform individuals’ drawdown strategies, such as the presence or absence of other retirement plans from previous employment; savings accrued in individual retirement accounts (IRAs); anticipated Social Security benefits; a spouse’s income; post-retirement pay; and any Roth features, which can bring fairly complex tax implications. In other cases a participant will have adult children or other family to support, or they may have unique financial objectives that will have to be considered.
Steve Vernon, a retirement adviser at the nonprofit Institutional Retirement Income Council, observes that Bill Sharpe, a previous Nobel Prize winner for economics, often said retirement income planning is “the hardest problem I ever looked at.”
But one cannot just ignore the challenge because it is great. Especially for plan sponsors with a sense of paternalism over their workers’ retirement years, helping participants create a well-structured system of withdrawals seems increasingly important. This means adviser opportunity, according to Lawrence and Vernon, as sponsors want help understanding the array of new products and services targeting this trend.
NEXT: Variables and more variables
For all the variables across participants reaching the withdrawal stage, two things are definite. First, good options are available in terms of specific products or services to make the drawdown process more controlled. Second, participants need good education to understand such products and to use them properly.
The adviser is ideally suited to provide this guidance, first to the sponsor, helping implement the right strategies, services and tools for its particular work force. Depending on his willingness to take on fiduciary responsibility, the adviser can then turn directly to the participants, helping them choose the best strategy for their individual lives.
“The plan adviser should take on that advice role [with the participants]—the fiduciary role,” says Vernon, who is also a consulting research scholar at the Stanford Center on Longevity. “That’s the value he adds. He should take the time to learn each person’s circumstances and then customize the advice to them.”
In terms of product selection, the sponsor—and ultimately participant—will likely be deciding between two basic approaches. These are systematic withdrawals from previously accumulated assets and various types of annuities—either in- or out-of-plan. The Center on Longevity recommends a combined strategy—what it calls a portfolio approach—that has the participant annuitize some assets while keeping others more liquid.
The adviser, as an unbiased party, can present the pros and cons of each—important because “it becomes tricky to find advisers who don’t have a stake in your financial decision in retirement,” Vernon says. “Often, in this debate over which is the more effective—and secure—alternative, the most vocal advocates for each are selling [that alternative]. So their recommendations are often self-serving.”
NEXT: Right-sizing the risk outlook
One complicating factor about annuities is the potential for portability issues. But, according to Bruce Ashton, a partner in the employee benefits and executive compensation practice group at Drinker Biddle & Reath LLP, some providers and industry advocacy groups have developed portability protocols, which, if adhered to by the administrator, make transferring a product from one provider to another relatively easy.
Still unresolved are litigation prospects. “The risks plan sponsors are concerned about include what their selection and monitoring obligations are, related to whether the provider offering a product will be around in 30 years,” Ashton says. He points to a safe harbor regulation on the subject, issued by the Department of Labor (DOL), as being problematic, but adds that the agency may revise it. “If and when that comes out, it will also spur more emphasis and more understanding and discussion of the issue,” he says.
With so much complication, what might a typical withdrawal strategy look like? Lawrence shares the scenario of a 65-year-old retiree who chooses to leave his Social Security benefits to ripen until he turns 70. Here, Lawrence applied the 3% rule, which would give the retiree $1,000 to live on each month for that first five years, totaling $60,000. “That’s a fair amount of money, and, for a large percentage of the population, that’s their 401(k) money,” he says. At 70, the retiree would begin taking Social Security and could invest whatever remained of his 401(k).
This example, of course, ignores market whims. Instead of the simplest take on the 3% or 4% rule, where the withdrawal amount is set at retirement and remains flat, “I like taking 3% of whatever’s there in a given year,” Lawrence says. “So if the market crashes, you take 3% of the lower balance and you live on that. It’s a tough year, but when the market goes up, you get a raise every year by taking out the same 3%. Otherwise, you can deplete the account very quickly.”
In either instance, delaying Social Security is key, and plan sponsors can aid their participants merely by explaining how that measure helps.
“For the participant who needs to retire at 65, the sponsor could help him postpone the benefit by adding a temporary payout feature to the plan,” Vernon says. This systematic withdrawal scheme would last for five years, paying him the monthly amount Social Security would when he reached 70. “By setting that up administratively and making it easy for the participant to check the box and implement, the sponsor is doing its participants a favor,” he says.