Analysis Supports 'Through' TDFs and Partial Withdrawals in DC Plans

Seven in 10 retirement-age participants (defined as those age 60 and older terminating from a defined contribution (DC) plan) have preserved their savings in a tax-deferred account after five calendar years, according to research from Vanguard.

In total, nine in 10 retirement dollars are preserved, either in an individual retirement account (IRA) or employer-sponsored DC plan account.

The three in 10 retirement-age participants who cashed out from their employer plan over five years typically held smaller balances. The average amount cashed out is approximately $20,000, whereas participants preserving assets have average balances ranging from $160,000 to $290,000, depending on the termination year cohort.

Only about one-fifth of retirement-age participants and one-fifth of assets remain in the employer plan after five calendar years following the year of termination. In other words, most retirement-age participants and their plan assets leave the employer-sponsored qualified plan system over time.

Vanguard examined the plan distribution behavior through year-end 2015 of 365,700 participants age 60 and older who terminated employment in calendar years 2005 through 2014.

One important question is how plan rules on partial distributions might affect participants’ willingness to stay within an employer plan. Eighty-seven percent of Vanguard DC plans in 2014 required terminated participants to take a distribution of their entire account balance if an ad hoc partial distribution was desired. For example, if a terminated participant has $100,000 in savings, and wishes to make a one-time withdrawal of $100, he or she must withdraw all savings from the plan—for example, by rolling over the entire $100,000 to an IRA and withdrawing the $100 from the IRA, or by executing an IRA rollover of $99,900 and taking a $100 cash distribution.

Only 13% of plans allow terminated participants to take ad hoc partial distributions. However, plans allowing partial distributions tend to be larger plans, and as a result, only three in 10 retirement-age participants are in plans allowing ad hoc partial distributions.

The analysis suggests participant behavior is affected by plan rules on partial distributions. For the 2010 termination year cohort, Vanguard analyzed participants in plans allowing partial distributions separately from those in plans that did not. About 30% more participants and 50% more assets remain in the employer plan when ad hoc partial distributions are allowed. In the 2010 cohort, five years after termination, 22% of participants and 26% of assets remain in plans allowing partial distributions compared with only 17% of participants and 18% of assets for plans that do not allow partial distributions.

Jean Young, senior research analyst at the Vanguard Center for Retirement Research and lead author of the study report, says these findings have implications for the design of target-date funds (TDFs) and retirement income programs. “The tendency of participants to preserve plan assets at retirement supports the notion of ‘through’ glide paths in target-date fund design. In other words, target-date designs should encourage an investment strategy at retirement that recognizes assets are generally preserved for several years post-retirement, she says.

“Also, with the rising importance of lump-sum distributions, participants will need assistance in translating these pools of savings into a regular income stream. Based on current retirement-age participant behavior, most of these retirement income decisions will be made in the IRA marketplace, not within employer-sponsored qualified plans, although this may evolve gradually with the growing incidence of in-plan payout structures and the new Department of Labor (DOL) fiduciary rule. One way sponsors might encourage greater use of in-plan distributions is by eliminating rules that preclude partial ad hoc distributions from accounts,” she concludes.

Data for the analysis comes from Vanguard’s DC recordkeeping clients over the period January 1, 2005, through December 31, 2015.