Times have changed since 401(k) plans were started back in the ’80s, just like hair styles and rock bands. Where most 401(k) plans only offered a lump-sum distribution option, the new trend in retirement plans may have you facing a decision. Could additional options, such as installments and ad hoc distributions, be the new featured value to plan participants? Could a lack of more distribution options be affecting participants’ distribution behaviors? Let’s look at the options and effects for the participants.
A 401(k) retirement plan that offers only a lump-sum distribution option requires participants to move the full account balance before they can even access one dollar from their accounts. While this may seem like no big deal, let’s turn this soup can around and read more about this lump sum on the label. It may provide greater insight into the lump-sum option.
If the need for cash at retirement is immediate, a participant may be forced to distribute the full account balance when the investment market is down. Participants would be locking in the investment loss on their entire account. This effect of the lump-sum distribution option affects participants whether rolling over their account or taking a distribution in cash.
These same lump-sum distributions can also adversely affect the plan as a whole. You may be scratching your head at this point and asking what do you mean? How can only having the lump-sum distribution option adversely affect the plan? Consider the scenario of a large population of plan participants retiring or terminating within a similar time period and possibly carrying away the larger balances in the plan. A tsunami of lump-sum distributions may trigger a significant drop in the total plan assets. This drop in assets may adversely affect the asset pricing structure for the remaining population of participants in the plan, creating a higher asset expense. Not to be a downer on lump-sum distributions, as they certainly have their place in retirement plans, but it may be time to consider offering additional options.
Installment payments can be a second option for a retirement plan. I like to call them the “Pac-Man” of the payment structures. This stream of same bite-size payments works like the Pac-Man arcade game. Pac-Man just kept munching his way around the board, eating until every bite was gone. The upside to installment payments is that participants can have a steady stream of income from the retirement plan and still remain invested. The participant continues to glean the benefit of lower investment pricing by remaining a participant in the plan. What participants should be considering, however, is the effect of these steady Pac-Man installment payments, which continue to happen in a downward investment market. Those installment payments can result in a larger reduction or faster depletion of a participant’s account than planned. For plan sponsors who offer the installment payment option, it is one way of potentially slowing down abrupt changes to the assets in the plan.
The third option, ad hoc distributions, may be considered the most flexible option in retirement plans. Let’s unpack how the ad hoc option can provide an ongoing investment benefit as well as distribution flexibility through retirement. Participants can leave their retirement accounts in the plan and remain invested in the plan’s institutional fund options. The ability to request a distribution when needed, or at the peak of a market upswing, can provide the ability to manage retirement drawdown. For participants who can afford to retire on other sources of income but may incur an unexpected medical cost during retirement, the ad hoc option provides a financial source to tap into only when needed.
Each distribution option has something to offer plan participants. Is it time to offer all three?