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An Effective Retirement Plan Does Not End at Retirement
Defined contribution (DC) plans, originally designed as supplemental savings vehicles, typically focus only on the savings phase — not the needs of retirees. Part of the reason for the historic success of the traditional defined benefit (DB) plan is that it is structured to provide participants retirement income directly from the plan.
To truly evolve into a complete retirement plan for American workers, the DC system needs to robustly serve participants in both the spending and saving phases. Sponsors can take the following steps to strengthen their DC plan to support participants in retirement.
- Evaluate core menu and target date options to address spending phase needs.
- Work with the recordkeeper to allow for choice in distribution strategies and efficient systematic withdrawals.
- Update employee communications and education materials to include specifics about the spending phase.
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Why DC Retirement Plans Should Continue Into Retirement
The days when employers were content to let employees convert their retirement savings to a payout stream outside of the plan are giving way to a realization that it is in everyone’s best interest to serve participants through retirement.
Most retirement plans offer some features for retirees, but many have not fully committed to gearing their plan for retiree needs:
• 20% of plans actively encourage participants to keep assets in the plan at retirement.
• 43% of 401(k) plans offer education regarding distributions at retirement.
• 60% of plans offer periodic or partial withdrawals.*
Encouraging participants to stay through retirement may not be a solution for every plan, but there may be tangible benefits of doing so for both retirees and sponsors.
Value to Retirees
Lower costs
Retirees may benefit from institutionally priced investments.
Oversight from investment committee
Retirees can continue to access professionally selected and monitored retirement investments.
Opportunity to consolidate retirement plan assets
“Roll-ins” can provide balance and coherence to assets scattered across former employer plans.
Reinforcement of good investing behaviors
The continuity of a plan avoids the abrupt shift that a rollover represents. Also, the plan may offer access to age-appropriate options such as target date funds.
Value to Plan Sponsors
Fee structure
More assets in the plan can drive down costs for all participants.
Increases employee engagement
Participants seeing retirement security as part of a total benefits package will be more likely to stay with the employer and to make responsible decisions as to when to retire.
Addresses potential decline in rollover advice
New rules put an intermediary’s rollover recommendation under the same standard of fiduciary care that the sponsor exercises toward the participant. Such scrutiny will potentially limit the availability of rollover advice for some participants over time and increase the desire for a retiree to stay in plan.
Flexibility in a changing workplace
The plan can better accommodate workers who retire early, return to work postretirement or never retire at all.
Create Investment Options for the Spending Phase
The spending phase is different from the saving phase. Regular portfolio withdrawals magnify the impact of market declines, making it challenging for those in retirement to recoup losses.
Plan sponsors should consider menu options aligned with the spending phase, such as:
1 Through Retirement Target Date Series
Target date series managed through retirement take into consideration the specific needs of retirees to help mitigate the risk of outliving retirement savings.
2 Distribution Alternatives for Retirees
Since the spending phase requires more predictable returns than the saving phase, plan sponsors may wish to offer managed portfolios that target a specific payout stream.
Retiree investment options should be:
• Managed for withdrawals • Predictable
• Understandable • Liquid
• Durable • Reasonably priced
Consider Creating a Retirement Tier
Plan sponsors may wish to create an additional retirement tier in their DC menu. This could include a few easily understood options that are geared toward different rates of withdrawals.
Here’s what an investment structure with a retirement tier could look like — simple, direct and understandable.
“Other industrialized countries routinely include retirees with active employees in retirement plans. They know pulling retirees out of the equation creates an unbalanced and unsuccessful retirement system.”
“What’s safe and what’s risky changes over the life course; the future of the U.S. pension system really requires employers to develop a holistic way to address retiree needs.”
— Michael E. Drew, Professor of Finance at Griffith University, Brisbane, Australia
“As employers think about how to usher employees into retirement, they would be well served by looking at retirement not as a finish line but as a transition zone.”
— Toni Brown, CFA, Senior Vice President, Defined Contribution
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Action Steps for Sponsors to Retain Retirees
Plans of all sizes should consider the following steps to encourage retirees to stay in the plan:
- Talk to your recordkeeper
Most plans can facilitate lump-sum and systematic withdrawals, but not all recordkeepers support ad hoc distributions for participants. Working with the recordkeeper to build this into the plan can encourage greater retiree participation. - Look at fees
Examine the expense structure of distribution fees to determine whether they support retirees’ needs. - Design withdrawal programs into the plan document
Many plan documents are already broad enough to allow partial distributions and enhanced payout options, but some may have to be amended. - Include retiree retention in participant communications
Ensure that all participants understand that they are allowed to stay in the plan after retirement. You may also wish to provide education on how to manage assets during retirement. - Target pre-retirees for educational outreach
Pre-retirement education can help participants understand the advantages of staying in the plan, the optimal withdrawal rate, and the importance of consolidating retirement assets.
Action Steps for Sponsors to Retain Retirees
Plans of all sizes should consider the following steps to encourage retirees to stay in the plan:
- Talk to your recordkeeper
Most plans can facilitate lump-sum and systematic withdrawals, but not all recordkeepers support ad hoc distributions for participants. Working with the recordkeeper to build this into the plan can encourage greater retiree participation. - Look at fees
Examine the expense structure of distribution fees to determine whether they support retirees’ needs. - Design withdrawal programs into the plan document
Many plan documents are already broad enough to allow partial distributions and enhanced payout options, but some may have to be amended. - Include retiree retention in participant communications
Ensure that all participants understand that they are allowed to stay in the plan after retirement. You may also wish to provide education on how to manage assets during retirement. - Target pre-retirees for educational outreach
Pre-retirement education can help participants understand the advantages of staying in the plan, the optimal withdrawal rate, and the importance of consolidating retirement assets.
Action Steps for Sponsors to Retain Retirees
Plans of all sizes should consider the following steps to encourage retirees to stay in the plan:
- Talk to your recordkeeper
Most plans can facilitate lump-sum and systematic withdrawals, but not all recordkeepers support ad hoc distributions for participants. Working with the recordkeeper to build this into the plan can encourage greater retiree participation. - Look at fees
Examine the expense structure of distribution fees to determine whether they support retirees’ needs. - Design withdrawal programs into the plan document
Many plan documents are already broad enough to allow partial distributions and enhanced payout options, but some may have to be amended. - Include retiree retention in participant communications
Ensure that all participants understand that they are allowed to stay in the plan after retirement. You may also wish to provide education on how to manage assets during retirement. - Target pre-retirees for educational outreach
Pre-retirement education can help participants understand the advantages of staying in the plan, the optimal withdrawal rate, and the importance of consolidating retirement assets.
Conclusion
Viewing DC plans as the retirement program of the future, the government enacted the Pension Protection Act of 2006 (PPA) to give plan sponsors the tools to improve participant outcomes. The effective use of auto-enrollment, auto-escalation and a QDIA can dramatically improve the likelihood of participants amassing enough assets to generate sufficient retirement income.
To become a complete retirement program, however, a DC plan must serve the needs of retirees as well as workers. The following steps to address the spending stage may help sponsors improve participants’ financial security in retirement:
- Ensure the investment menu can meet retiree payout needs.
- Consult with your recordkeeper to facilitate ad hoc and systematic withdrawals and, if necessary, amend your plan document.
- Deliver participant communications that reflect the pros and cons of staying in the plan.
Other Resources
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- Why Re-Enrollment Matters
Re-enrollment can lead to better participant outcomes.
- Is Passive Truly the Safer Fiduciary Choice for TDFs?
Passive investments do not have inherently greater fiduciary protection than active investments.
- Simplify Menus to Meet Participant Objectives
Fewer and easier-to-understand investment menu choices can encourage more appropriate selections.
- Why Re-Enrollment Matters
* Plan Sponsor Council of America’s 59th Annual Survey of Profit Sharing and 401(k) Plans, 2016.
Not all plans can accommodate retirement income options.
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the mutual fund prospectuses and summary prospectuses, which can be obtained from a financial professional, and should be read carefully before investing. Similar information about collective investment trusts can be obtained from Capital Group or participants’ plan provider or employer.
Content contained herein is not intended to serve as impartial investment or fiduciary advice. The content has been developed by Capital Group, which receives fees for managing, distributing and/or servicing its investments.
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and should not be considered advice, an endorsement or a recommendation.