Written by William Ryan
William Ryan is an Associate Partner and Head of Aon Hewitt’s target date fund research team, based in Chicago.
“When one door closes, another opens; but we often look so long and so regretfully upon the closed door that we do not see the one which has opened for us.” - Alexander Graham Bell
The importance of defined contribution (DC) plans has been increasing for years. DC plans have moved from being simply supplemental savings vehicles to primary retirement plans. The regulatory environment has been changing over the past three years with an emphasis on the DC plan’s importance and the overall role it will play in retirement. Recent efforts from Washington to improve DC plans include:
- Selection and Monitoring under the Annuity Selection Safe Harbor Regulation for Defined Contribution Plan, February 2015
- The “Fiduciary” Rule, April 2016 – Focus on ensuring that plan participants receive advice that is in their best interests.
- 401(K) Plans: DOL Could Take Steps to Improve Retirement Income Options for Plan Participants, August 2016
With this increasing momentum to make DC plans more effective as primary retirement plans, plan sponsors should think about how to set up DC plans to successfully support participants’ experience in producing retirement income. The coordination of both settlor and fiduciary functions is critical for creating a successful retirement income solution.
As plans consider their priorities, this is an opportune time for a plan design check-up so sponsors can think about the role that retirement income plays. Is the current plan design set up in a way that is flexible for retiring participants to draw retirement income?
To think about this further, let’s define participants’ withdrawal options:
- In-Service Distributions: Self-managed withdrawals taken once a person is over the age of 59 ½ and still employed
- Systematic Payments: Withdrawal amounts may be set by participants for a specific monthly or annual amount (e.g., $1,000) or for a percentage (e.g., 4 percent) of their remaining account balance
- Lump-sum Payments: Withdrawal of a participant’s full account balance in either cash or rolled over to another qualified plan or IRA
- Installment (Partial) Payments: Self-managed withdrawals are made over a period of time and can include one-time withdrawals of a portion of an account balance
Most plan designs accommodate 1 – 3, but a potential enhancement is adding the withdrawal flexibility of item 4 Installment (Partial) Payments. The recent GAO report cites a study that 87% of plans require a participant to take a lump-sum payment when attempting to take a partial payment.
Why is lack of partial payments a hurdle?
It forces participants to make a decision between an institutionally-priced DC plan and a retail-priced IRA for their entire balance when they are only trying access part of their assets. Providing flexibly in the way a participant can draw income from a DC plan further supports the overarching theme of the pending Fiduciary Rule, placing participants’ best interest first. Plans could consider the possibility of permitting partial payments for terminated employees as well as other alternative payment options rather than just a full “lump sum” distribution. There are cons to this approach, which include requiring plan sponsors and vendors to service terminated participants. This can add complexity to the administration, such as an increased number of death benefits to be administered. As with many decisions, there are pros and cons. However, reviewing the overall philosophy of the plan and evaluating alternatives will help ensure that you are designing your plan for the long term.
We have seen studies that as little as 32% of participants remain in a plan three years after retirement. Further looking at Aon Hewitt data, we see that 43% of participants with a balance greater than $100,000 will rollover their account balances post-employment. We wonder how much of that movement is driven by the inability to access partial withdrawals.
Source: Aon Hewitt 2015 Universe Benchmarks Report
Opening the Doors for DC Retirement Income
Times are changing with the movement to improve retirement coverage for American workers paired with the increased encouragement to convert those retirement balances into streams of income. To address these changes, we think offering flexible withdrawal options, similar to those offered via in-service withdrawals, will allow for more predictable participant behavior. Improvements in predictability will allow retirement income solution providers to design more adaptive products and plan to better support participants in their benefit payment years.
The absence of a partial withdrawal option may have made sense when DC plans were supplemental savings plans, but the environment has changed. Plan design changes are a settlor function that can be taken to enhance retirement income options and can lead to fiduciaries discussing additional strategies to support successful participant outcomes. Making plan design conversations during annual reviews, in advance of the industry developing standard retirement income solutions, provides sponsors the ability to drive this DC evolution. Setting up the plan design in way that is friendly to retirement income will allow providers to build a more informed solution for each plan.
Why should this conversation occur now? Participants near retirement are facing a decision to stay in plan or rollout. As plans prepare for the pending Fiduciary Rule, which is intended to allow participants to retain reasonably-priced investments, providing participants a mechanism to stay within institutional priced plans may be in their best interest.
Things to Consider:
- Discuss the role of retirement income
- Review current withdrawal options across both plan documents and record-keeper operational procedures
- Consider the benefits of a partial withdrawal option
 US Government Accountability Office (GAO) GAO-16-433
 Vanguard: 2016 How America Saves
 JP Morgan: Ready! Fire! Aim? 2015
 Aon Hewitt 2015 Universe Benchmarks Report
 Department of Labor (DOL) Field Bulletin No. 2015-02
 DOL 29 CFR Parts 2509, 2510, and 2550
 US Government Accountability Office (GAO) GAO-16-433
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