Plan Distribution Behavior Dictated By Plan Design

New DCIIA research put together in concert with a large group of retirement industry service providers highlights the crucial role plan design plays in terms of participants' decumulation decisions.

Because individuals’ financial needs in retirement can vary over time and from one person to another, it is crucially important that a defined contribution (DC) plan offer an array of retirement income and distribution options, according to the latest research from the Defined Contribution Institutional Investment Association (DCIIA).

According to “Design Matters: Plan Distribution Options,” DC plan sponsors are increasingly concerned about effectively providing participants with the retirement income flexibility they need and want after separation from active service. However, they face uncertainty about what are the best approaches. 

The analysis was put together by an impressive list of retirement industry analysts: Jessica Sclafani, Cerulli Associates; Rennie Worsfold, Financial Engines; Doug Keith, GMO; Elizabeth Heffernan, Hueler Income Solutions; Cynthia Mallett, MetLife; Jim Smith, Morningstar; Mark Fortier, NISA Investment Advisors; Don Stone, Pavilion Advisory Group; Tom Johnson, Retirement Clearinghouse; Jody Strakosch, Strakosch Retirement Strategies; Rachel Weker, T. Rowe Price Associates; Mark Foley, TIAA; Kate Jonas, Nuveen; and Don Stroube, Wells Fargo.

Combining insights from these various providers and research organizations, DCIIA’s report argues that plan sponsors must better evaluate their plans’ objectives with respect to retired and separated participants—and then determine if the plans’ retirement income and distribution options align with these objectives. This may sound like a straightforward task, but as the research lays out, setting plan objectives remains one of the most challenging tasks that plan officials face, let alone the issue of pursuing these objectives effectively over time.

“A pivotal question for sponsors to answer is whether they want their plans to encourage plan participation to continue through retirement, or rather, to actively encourage distribution of assets once active service separation has occurred, either as a result of a job change or retirement,” the researchers suggest. “Plan sponsors’ decisions about their plans’ distribution policy can play a critical role in their participants’ retirement outcomes.”

Looking across today’s DC plan marketplace, the researchers suggest it is much more common to see plan designs that are tailored to drive retired or terminated participants out of the plan. These plans generally only provide one or a few types of single lump-sum options, such as cash-outs, direct rollovers to another employer’s DC plan, or direct rollover to an individual retirement account (IRA) or rollover annuity. On DCIIA’s analysis, all of these options “align much more with plan sponsors’ desire for separated participants to exit the plan.”

The DCIIA research suggests options that encourage participants to remain in-plan are only “moderately prevalent,” if even that. Partial withdrawals, for example, are seen by DCIIA as “retiree friendly” but they are still not very widespread. Qualified in-plan annuities are even less prevalent, though they are also viewed as “retiree friendly” in terms of keeping participants in-plan once they terminate.

While the industry has a long way to go before it is as effective at promoting rational decumulation as it is at promoting asset accumulation, DCIIA finds some emerging evidence that “plan sponsors, consultants and advisers are beginning to reconsider whether guiding participants towards lump-sum distributions, intentionally or unintentionally, through plan designs that encourage such distributions, is the most appropriate approach.”

“Increasingly, plan sponsors have begun to realize that options such as periodic partial withdrawals, partial annuitization, monthly/quarterly installment payments and other flexible distribution strategies can allow retired and other separated participants to readily turn their account balances into the type of income stream that best meets their individual financial needs,” the report says. “In short, they realize plan design (in this case, the distribution options available to participants, and the framing of those options) matters.”

The research indicates that when DC plans offer distribution options alongside a one-time lump-sum benefit payment, a good number of retiring plan participants are interested in, and take advantage, of these options. For instance, among the approximately 20% of Vanguard plans that permitted partial distributions, simply offering them produced notably different participant behavior. About 30% more participants and 50% more assets remained in the employer plan when partial distributions were allowed.

As researchers point out, today most retirement-age participants and their plan assets leave the employer-sponsored qualified plan system over time, “but this termination behavior associated with lump sum payouts seems linked to plan rules that inhibit ad hoc or flexible withdrawals from DC plans.” Importantly, researchers conclude, allowing participants the flexibility to remain in the employer-based retirement framework can have significant benefits, not only for plan participants, but also for plan sponsors.

“Retirees who elect to stay in the plan or who return to employment benefit from the plan’s fiduciary standard of care, and maintain access to cost-effective, institutional investment offerings, often at lower cost than what is available to them in the retail marketplace,” the research highlights. “Moreover, all participants in the plan—no matter their age or how far from retirement they are—can benefit from increased economies of scale due to more participants remaining in the plan, which can further lower costs for everyone.”

At the same time, DCIIA says, plan sponsors serving as fiduciaries also benefit from providing their plan participants access to lower fees that result from the greater asset levels.

The full analysis can be downloaded here.