401(k) Shift Equals Prolonged Retirement

The lack of explicit early retirement incentives often put in pension plans was found to be the leading cause for the extended work life. This was tied to a hangover of provisions originally developed in defined benefit plans to encourage workers to retire as their productivity starts declining. Thus, pension plans often pay more in lifetime benefits to individuals who retire at age 55 or 60 than to those who retire at 65, according to the Center for Retirement Research at Boston College (CRR) study.

As an example, the study provides a person that will live for 20 years and is entitled to a pension of $15,000 at age 65 – totaling a lifetime of benefits that will equal $300,000. If the worker was contemplating retiring at 55, the annual benefit should be only $10,000 annually to keep lifetime benefits constant. However, traditional defined benefit plans typically provide far more because they use an actuarial reduction that is smaller than the full reduction. In this example, the study said instead of the $10,000 benefit, companies will often pay something closer to $12,000 at age 55, which means that the worker in this example who retires at 55 would receive substantially more in lifetime pension benefits than if he were to retire at 65.

Distributing the Difference

Distribution differences also played a key part in 401(k) participants staying on longer. The study found benefits in 401(k) plans are typically paid out as a lump sum rather than as a lifelong stream of monthly payments. Therefore, individuals may behave differently when receiving lump sums, tending to spend more slowly to avoid running out of money. In this case, many prefer to compensate by working longer to build up a larger lump sum.

In the same vein, workers are apparently skittish about the 401(k) plans’ reliability due to investment risk. This source of uncertainty may make workers more cautious about leaving the labor force.

Additionally, after the retired worker receives the lump sum, they then must figure out how to invest it and estimate the interest they will receive on this investment.The presence of this investment uncertainty may cause some individuals to err on the side of caution and stay in the workforce longer than if they had a more predictable income stream from a defined benefit plan.

The survey is based on an analysis of data from the Health and Retirement Study. A copy of the full report can be found at www.bc.edu/crr or by calling (617) 552-1762.