Economic security in retirement can be significantly undermined by job changes and by certain choices workers may make about when and how to receive distributions from their retirement plans. Changes in the design of both defined-benefit and defined-contribution plans could help workers ensure larger benefits in retirement.
Job changes can affect the value of benefits received at retirement under a defined-benefit plan. When workers who are vested in defined-benefit plans change employers, their accrued benefit is fixed in nominal terms until they reach retirement age. The value of deferred benefits that remain in a former employer’s plan may be substantially eroded by inflation by the time the employee reaches retirement age.
Job changes can also affect participants in defined-contribution plans, but in a different way. Defined-contribution plan participants can often roll over funds to a plan at their new employer, although some portability barriers exist between different types of plans. At the very least, lump sums can be rolled over into an individual retirement account (IRA). A large share of the balances of IRAs is accounted for by such rollovers.
However, many plan participants choose to cash out these accounts rather than rolling over the funds into another retirement savings vehicle. According to Census Bureau data, millions of people reported having at some time received a lump-sum distribution from their own retirement assets or as a survivor of a family member with such a plan. Less than half (45 percent) of these beneficiaries reported using all or part of the distribution for tax-qualified savings. Millions of Americans are jeopardizing their future retirement income security by spending the money they receive from a retirement savings plan prior to retirement.
Policymakers have already taken some steps to discourage people from prematurely cashing out their retirement accounts. Since 1993, federal law requires that disbursed lump-sum retirement funds that are eligible to be rolled over into an IRA be directly transferred to an IRA or other retirement vehicle, or be subject to a 20 percent withholding tax. In 2000 the law was changed to require that amounts between $1,000 and $5,000 be automatically rolled over unless the employee requests a distribution. The US Treasury has issued final regulations that facilitate automatic rollovers.
When an employer files for bankruptcy, defined-benefit pension plan participants should be included in Chapter 11 creditors’ committees as a matter of right, and collective-bargaining agreement plan participants and non-agreement participants should be represented separately.
Retirement security can be enhanced for many older Americans by increasing their awareness and understanding of annuities and other periodic withdrawal options. A greater understanding of the way annuities work and the longevity insurance they provide will require enhanced education programs at workplaces. This effort should be part of a more general campaign at the workplace and in school to improve financial literacy. Making annuities effective as the default distribution vehicle may require some revisions to the existing safe-harbor provision to allay any fear that plan sponsors may have of being sued by disgruntled annuitants. Neither the offering of annuities nor their purchase should be compulsory, however. The broader market for annuities that this default measure would create should lower the cost of these products, as should measures that encourage group annuity purchases.
Two other distribution issues are critical. First, the rules and choices regarding retirement plan distributions can be complex and confusing, and they need to be simplified. These often irreversible decisions have a direct impact on long-term economic security and are commonly accompanied by significant tax consequences. Second, some workers who are eligible to receive a benefit from a former employer are unable to locate that employer’s plan. This problem is more likely to arise when the employer has gone out of business or has been taken over by another company.
Portability, Preservation, and Distributions: Policy
Greater portability is needed to protect the value of vested retirement benefits and ensure an adequate retirement income for workers who change jobs.
Retirement plan distribution rules should be simplified to improve long-term economic security.
To protect benefits that would otherwise be cashed out, rollovers of lump-sum retirement benefits into another retirement vehicle should be automatic, and the regulatory framework modified to discourage preretirement access to such funds.
Annuitization options provided by plan sponsors should be low-cost, transparent, cost-effective, and safe. Recipients should receive information on how plan rules, the value of underlying assets, or economic conditions may influence payouts.
Employers should be required to provide departing workers with several options with respect to accumulated assets in their retirement savings plan, including leaving the assets in the account or withdrawing a portion of the assets through one-time or periodic distributions.
Policymakers should forbid employers from pressuring departing workers to take a lump-sum distribution.
Greater protection than what is currently available should be afforded retirement plan participants in plan-sponsor bankruptcy proceedings.
AARP supports the creation of a public- or private-sector agency to assist in recording current retirement plans through a central registry and in finding lost benefits.