After many years of saving in a defined contribution (DC) plan, what does a retirement-age participant typically do with the money they’ve accumulated? New research by Vanguard breaks it down.
As an issue that has increasingly piqued the interest of policymakers, plan sponsors and recordkeepers, Vanguard set out to explore what near-retirees do with their plan balances after leaving their employer and whether plan designs should offer various retiree-friendly attributes that help participants convert their savings into sustainable income streams. They also looked at whether the glide path of target-date funds (TDFs) should be based on a “to” or “through” retirement approach.
In “Retirement Distribution Decisions Among DC Participants,” coauthors Jeffrey W. Clark and Joseph C. Walsh examine the decisions made by participants ages 60 and older — defined as “retirement-age” participants — who have separated from service with their employer. Most specifically, they examined the plan distribution behavior through year-end 2021 of 504,400 participants ages 60 and older who terminated employment in calendar years 2011 through 2020.
Perhaps one of the biggest findings is that nearly 7 in 10 retirement-age plan participants have preserved their savings in a tax-deferred account. In total, 9 in 10 retirement dollars are preserved, either in an IRA or employer plan account.
In addition, most retirement-age DC plan participants leave their employer’s retirement plan within five years of separation from service — mostly for a rollover to an IRA. However, when plans permit more flexible distribution options, retirement-age participants and their assets are more likely to remain in the employer’s plan. In fact, the percentage of plans that offer this feature has nearly doubled in the past five years, along with an increasing demand for retiree-friendly plan designs, in-plan advice and retirement income solutions, the report notes.
Plan Rules and Partial Distributions
So how might plan rules on partial distributions affect participants’ willingness to stay in an employer’s plan?
According to the research, 37% of Vanguard DC plans in 2021 allowed terminated participants to take ad hoc partial distributions — up from 19% in 2016. Not surprisingly, this feature is more common with larger plans, as nearly three in four plans with 5,000 or more participants allow partial distributions. “As a result, 72% of participants were in plans that allowed ad hoc partial distributions in 2021, up from 41% in 2016,” Dave Stinnett, Vanguard’s Head of Strategic Retirement Consulting, tells NAPA.
For the 2016 termination year cohort, the firm analyzed participants in plans that allowed partial distributions separately from participants in plans that did not. Their distribution behavior followed a similar trend over time. Nearly 20% more participants and 25% more assets remained in plans when ad hoc partial distributions were allowed, according to the data.
What’s more, five years after termination, 23% of participants and 38% of assets remained in plans allowing partial distributions compared with 19% of participants and 28% of assets for plans that did not have this feature. “This suggests that not allowing partial distributions is a factor leading participants to leave their employer’s plan,” Clark and Walsh observe in the report.
However, there is a trend in more recent retirement-age participants remaining in the plan, perhaps incentivized as retirement plans provide features that increase withdrawal flexibility, the report further notes.
Meanwhile, most retirement-age IRA-owning households and most IRA assets were not accessed until after age 70, when the RMD rules apply. These findings have implications for two issues: the expected demand for in-plan retirement income programs and the “to versus through” debate in the design of the glide path for target-date funds.
Regarding retirement income programs, as participants are increasingly remaining in their plan, plan sponsors may want to consider various retiree-friendly plan designs to help their retired participants.
When asked whether they are seeing more plan sponsors wanting to keep participants in the plan, Stinnett told NAPA that they are seeing a trend in this area, particularly for long-tenured employees.
Not surprisingly, smaller balance accounts from low-tenured employees (less than $5,000) are still often being cashed out through the permitted auto-cash out.
Vanguard’s data also shows that the average balance of participants cashing out their entire account balance was around $39,700 in all termination year cohorts. By comparison, the average balance for participants using any other strategy — remaining in the plan with or without installments, rolling over to an IRA, or using a combination of these—was between $190,800 and $476,300, depending on the strategy and termination year cohort.
“Plan sponsors looking to decrease cash outs among their participants may want to consider implementing plan design best practices such as removing plan age restrictions, allowing for installments, and permitting flexible withdrawals,” Stinnett suggests.
When these types of features are paired with benefits such as cost-effective advice, institutional pricing and ongoing fiduciary oversight, many retirees may find additional value in remaining in the plan, the Vanguard executive further suggests.
‘To’ vs. ‘Through’
In terms of TDFs, with the findings showing that most plan assets are preserved in tax-deferred retirement accounts, participants’ strong tendency to preserve assets for retirement supports a “through” glide path—in other words, a glide path that assumes participants will remain invested into retirement.
As an example, the default glide path for Vanguard TDFs is a final 30% equity allocation at age 72, which supports participants whose primary investment objective is stable inflation-adjusted income to cover basic living expenses.
“Investors in or approaching retirement still have long runways and the diversification and growth potential that comes with equities can offset costs (e.g., heath care) that is unique to this cohort,” explains Stinnett. Moreover, he adds that the shift to fixed income also aligns with both the point at which investors typically begin to withdraw assets from their tax-deferred portfolios in meaningful amounts and the age at which they begin taking RMDs.