401k advisors and their plan sponsor-clients might want to take a closer look at the ways in which participants withdraw benefits from their retirement accounts. The most common distribution practices may be missing the mark, according to the Defined Contribution Institutional Investment Association (DCIIA).
In a new white paper, Design Matters: Plan Distribution Options and Taking Money Out for Retirement, DCIIA outlines less common distribution methods that may align better with the goals and interests of plan sponsors and their participants.
For instance, research obviously reflects a widespread shift away from defined benefit (DB) plans toward defined contribution (DC) as Americans’ primary retirement savings vehicle. But because DC plans were initially designed to supplement payouts from DB plans, DC benefits are most commonly distributed as a lump sum through cash-outs or rollovers.
It doesn’t bode well for participants who are seeking to convert assets into a lifetime income stream upon retirement, of which there are many. In fact, a 2017 Cerulli survey found 44.3 percent of respondents said that such a conversion was the most important topic they considered when planning for retirement.
Plan sponsors seem to agree: “According to the MetLife 2016 Lifetime Income Poll, 85 percent of plan sponsors now believe that retirement income should be the core purpose of a DC plan; four years earlier, only 9 percent of plan sponsors held that opinion,” DCIIA said in its report.
What’s more, plan sponsors would often prefer to retain departing employees’ and retirees’ assets for the perks associated with greater AUM (lower fees, cost-effective investment options potential for larger returns, etc.). However, plan sponsors are inadvertently directing assets elsewhere by failing to offer distribution alternatives.
As such, DCIIA recommends considering the following “retiree-friendly distribution options”:
- Partial withdrawals: flexible, periodic withdrawals at irregular intervals, somewhat similar to a savings account
- Installment payment programs: specified payout amount at a predetermined interval, similar to a paycheck
- Annuities: guaranteed income stream, whether immediate (payout begins within 12 months), deferred (payout begins in three to five years), or a Qualified Longevity Annuity Contract (guaranteed payout if participant outlives life expectancy, typically beginning at age 85)
To evaluate and improve distribution options, DCIIA provided a checklist. Advisors and plan sponsor-clients should:
- Identify current “money out” options.
- Check whether the plan allows for partial withdrawals.
- Evaluate whether the plan’s current options align with goals and objectives for the plan’s future.
- Request an analysis of participant distribution history from the recordkeeper in order to identify what current participants have been doing; also examine demographic data to estimate how many participants will reach retirement age in the next 5, 10 or 15 years.
- Consider incorporating retiree-friendly distribution features and determining what plan document changes would be required to introduce such features.
- Evaluate the treatment of beneficiary payments and whether the only distribution option is a lump-sum withdrawal.
- Consult with the recordkeeper to determine best practices and what is possible for the plan.
- Communicate distribution enhancements to plan participants.
“Plans operating and intended solely as supplemental savings vehicles may prefer to limit their distribution options, or perhaps favor offering only the full-withdrawal option for retirees. Plans intended to ensure retirement income, such as those where a DB plan has been phased out or terminated, may instead want to consider other distribution options, ones that enable the participants to use the plan after separation from active service, thereby helping them to meet their income needs and spending priorities through retirement,” DCIIA concluded.
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
