'Through' TDFs May Make Sense

An analysis of defined contribution (DC) plan participant distribution behavior supports the use of “through” target-date funds (TDFs) and the allowance of partial distribution options to help participants develop retirement income strategies.

Seven in 10 retirement-age participants—defined as those ages 60 and older terminating from a defined contribution plan—have preserved their savings in a tax-deferred account after five calendar years, according to research from Vanguard.

In total, nine in 10 retirement dollars are preserved either in an individual retirement account (IRA) or employer-sponsored defined contribution plan account.

The three in 10 retirement-age participants who cashed out from their employer plan over five years typically held smaller balances. The average amount cashed out is approximately $20,000, whereas participants preserving assets have average balances ranging from $160,000 to $290,000, depending on the termination year cohort.

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 will eventually leave the employer-sponsored qualified plan system.

Vanguard examined the plan distribution behavior through year-end 2015 of 365,700 participants ages 60 and older who terminated employment in calendar years 2005 through 2014.

One important question is how plan rules on partial distributions might affect participants’ willingness to stay within an employer plan. Eighty-seven percent of Vanguard defined contribution plans in 2014 required terminated participants to take a distribution of their entire account balance if an ad hoc partial distribution was desired. For example, if a terminated participant had $100,000 in savings and wished to make a one-time withdrawal of $100, he had to withdraw all savings from the plan—say, by rolling over the entire $100,000 to an IRA and withdrawing the $100 from that, or through executing an IRA rollover of $99,900 and taking a $100 cash distribution.

Only 13% of plans allow terminated participants to take ad hoc partial distributions.

Additionally, these tend to be larger plans, and, as a result, only three in 10 retirement-age participants are in plans allowing such distributions.

The analysis suggests participant behavior is affected by plan rules on partial distributions. For the 2010 termination year cohort, Vanguard analyzed the behavior of participants in plans allowing partial distributions separately from those in plans that did not. About 30% more participants and 50% more assets remain in the employer plan when partial distributions are allowed. By 2015, 22% of participants and 26% of assets still remained in plans allowing partial distributions.