For defined-contribution (DC) plans, the amount of assets available to people when they retire depends on two factors: the amount they save over the course of their working lives and whether they leave those savings in the retirement plan or use them to pay for other expenses prior to retirement. Public policies can help to ensure that people preserve savings for retirement by, for example, making it easier for workers to leave assets in retirement plans when they change jobs and when they reach retirement age rather than cashing out their accounts.
Millions of Americans jeopardize their future retirement income security by spending the money they receive from a retirement savings plan prior to retirement. When participants in DC plans change jobs, they must decide how to handle the assets they have accumulated in their retirement account. They can roll over funds to a plan at their new employer, or to an individual retirement account (IRA). 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 receiving 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 individuals reported using all or part of the distribution for tax-qualified savings. Policymakers have already taken some steps to discourage people from prematurely cashing out their retirement accounts such as by requiring that eligible retirement assets be transferred directly to an IRA or be subject to a 20 percent withholding tax as well as a 10 percent tax penalty. Since 2000, the law allows employer plans to automatically roll over amounts between $1,000 and $5,000 into an IRA unless the employee requests a distribution.
The value of benefits from defined-benefit (DB) plans depends in part of the number of years a worker participates in the plan. Changing jobs reduces the number of years the person participates in any single plan. The resulting pension benefits will therefore be lower than otherwise. In addition, benefits from DB plans are fixed at the point when the worker leaves the organization. The benefit does not increase with inflation and therefore can lose a considerable amount of value over time.
Workers in both defined-benefit (DB) and DC plans must make decisions about how to receive distributions from their retirement plan. These choices vary depending on the type of retirement plan, creating complexity and confusion and possibly resulting in significant tax consequences. In the past, most DB plans paid benefits in the form of annuities. More often now, participants in DB plans can choose to receive their benefit as a lump sum. Similarly, even though more DC plans are allowing participants to elect to receive their benefits as an annuity, this option is still only offered by a small minority of plans. Some employers also allow their workers to make periodic withdrawals. By providing a guaranteed monthly benefit, annuities can help workers to ensure that their retirement benefits will last their entire lives. However, relatively few workers choose the annuity option.
Due to adverse selection, annuities are currently relatively expensive. People who are healthy and expect to live a long time tend to be the ones who purchase annuities, whereas people with family histories of dying young do not. Making annuities a default distribution vehicle for retirement plans could lower the cost of these products, as should measures that encourage group annuity purchases.
Two additional factors can negatively affect the retirement benefits available to workers in retirement. First, some workers are unable to locate a former employer’s plan due to the employer having gone out of business or having been taken over by another company. Second, workers may lose DB pension benefits if an employer files for bankruptcy.
PORTABILITY, PRESERVATION, AND DISTRIBUTIONS: Policy
Policymakers should facilitate greater portability of retirement plans to protect the value of vested retirement benefits and ensure an adequate retirement income for workers who change jobs.
Rollovers of lump-sum retirement benefits into another retirement vehicle should be automatic, and the regulatory framework should be modified to discourage preretirement access to such funds.
Greater protection than what is currently available should be afforded retirement plan participants in plan-sponsor bankruptcy proceedings.
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. Policymakers should support 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.
Distribution and withdrawal options
Retirement plan distribution rules should be simplified to improve long-term economic security.
Policymakers should explore options for increasing the share of retirement wealth that is annuitized.
Employers should offer fixed annuities or other vehicles that are inexpensive, transparent, cost-effective, and safe. Recipients should receive information regarding how payouts may be influenced by plan rules, the value of underlying assets, or economic conditions.The Department of Labor should strictly enforce employers’ fiduciary duty when choosing a provider for delivering annuity payments to plan beneficiaries. There should be an effective insurer of last resort to provide protection for beneficiaries if insurance companies providing annuities fail.
Policymakers should require employers to provide retiring workers with several options with respect to accumulated assets in their retirement savings plan, including leaving the assets in the account, taking their benefits in the form of an annuity or similar lifetime income vehicle, or withdrawing a portion of the assets through one-time or periodic distributions.Policymakers should forbid employers from pressuring retiring workers to take a lump-sum distribution.