Article

Lump-Sum Distributions from Retirement Saving Plans: Receipt and Utilization

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Abstract

One of the central issues in evaluating the ongoing shift from defined benefit (DB) to defined contribution (DC) pension plans is the degree to which assets in DC plans will be withdrawn before plan participants reach retirement age. The annual flow of withdrawals from such plans, which are known as lump sum distributions and which are frequently but not always associated with employment changes, has exceeded $100 billion in recent years. This flow is substantially greater than the flow of new contributions to IRAs and other targeted retirement saving programs. This paper draws on data from the 1993 Current Population Survey and the Health and Retirement Survey to summarize the incidence and disposition of lump sum distributions. We find that while less than half of all lump sum distributions are rolled over into IRAs or other retirement saving plans, large distributions are substantially more likely to be saved than smaller ones are. Consequently, more than half of the dollars paid out as lump sum distributions are reinvested. We also explore the correlation between various individual characteristics and the probability of rolling over a lump sum distribution. This is a first step toward developing a model that can be used to evaluate the long- term effects of lump sum distributions, or policies that might affect them, on the financial status of elderly households.

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... While a fairly extensive literature has analyzed employee participation and contribution decisions with regard to ESPs, considerably less attention has been given to pre-retirement withdrawal decisions. Much of the prior research on withdrawals has analyzed the influence of basic household and plan characteristics (Andrews, 1991; Bassett et al., 1998; Purcell, 2002; Poterba et al., 1998; Sabelhaus and Weiner, 1999). From this literature a number of stylized facts about early withdrawals has emerged. ...
... Despite the tax-based disincentives, participants in plans offering lump-sum distributions at job separation have cashed out at a surprisingly high rate. In fact, most studies have found that a majority of participants take at least some money from their plan when leaving an employer (Andrews, 1991; Bassett et al., 1998; Purcell, 2002; Poterba et al., 1998; Sabelhaus and Weiner, 1999). This has raised the question of how responsive participants really are to the tax incentives to preserve the tax-deferred status of their plan balances when leaving a job. ...
Article
This thesis investigates why, in spite of the high tax and opportunity costs, a substantial fraction of workers withdraw money from their employer-sponsored retirement accounts upon leaving a job. I employ three national surveys--the National Longitudinal Survey of Youth 1979 (NLSY79), the Survey of Consumer Finances (SCF) and the Survey of Income and Program Participation (SIPP)--to evaluate explanations for this behavior. Often attributed to poor decision-making, withdrawals from employer-sponsored plans may in fact serve as an important mechanism for liquidity-constrained workers to smooth consumption in response to income shocks. Results from the NLSY79 suggest that withdrawals do appear to be driven largely by need, as workers who faced jobless spells upon separation as well as those with low holdings of liquid assets, and poor access to consumer credit markets, were significantly more likely to take some money from their retirement plans when leaving an employer. Yet there was little evidence to support the hypothesis that workers who suffered an adverse job separation were more likely to withdraw money from their plans if they were also liquidity constrained. The second chapter estimates the tax sensitivity of withdrawal decisions using estimates of effective federal and state marginal tax rates generated with the NBER Taxsim program. Estimates reveal that, depending on the tax price measure used, a one percent increase in the marginal tax rate increased the probability that workers preserved the tax-deferred status of the money in their retirement plans between 10 and 30 percentage points. State-level penalties for early withdrawals were also found to be an effective policy instrument for deterring cash outs among workers under age 55. In the third chapter, I take advantage of measures of savings goals and habits, as well as more specific information on the use of cash settlements, found in the SCF to further investigate behavioral explanations for disposition of employer-sponsored plans. Workers who reported credit constraints, a short planning horizon, not saving primarily for retirement and a major future expense for which they had not yet begun saving were significantly more likely to take money from their plans.
... Workers who spend their distributions instead of rolling them over into Individual Retirement Accounts (IRAs) or other tax–qualified accounts will not accumulate much pension wealth at retirement. Studies find that most people who take lump–sum distributions do not roll them over into qualified accounts (Burman, Coe, and Gale, 1999; Poterba, Venti, and Wise, 1998; Sabelhaus and Weiner, 1999; and Yakoboski, 1997). However, the likelihood of rolling over a distribution Note: The sample is restricted to men and women who worked for pay at some point in their lives. ...
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The conversion of traditional defined benefit plans to cash balance plans is among the most controversial aspects of pension policy today. Because the controversy has focused on the treatment of older workers, however, the debate has generally ignored the long-term implications for retirement security. This article examines the potential impact of cash balance plans on workers who spend their entire careers in these plans, and focuses on the implications for mobile workers and for labor supply at older ages. The evidence suggests that cash balance plans can often provide more retirement security than traditional defined benefit plans or defined contribution plans.
... To combat these problems, the company hired an investment consultant to meet with employees and help them plan their retirement savings. After an initial interview with each employee, the consultant would gauge the employee' should note, however, that previous research also suggests that although small distributions tend to be consumed rather than rolled over into other retirement savings vehicles, these small distributions represent a relatively small fraction of total retirement savings (Poterba, Venti and Wise 1998a; Engelhardt 2002). Thus, while automatically rolling such distributions over into an IRA will undoubtedly increase retirement saving, its impact on aggregate retirement saving is likely to be modest. ...
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... 22 Retirees may face adverse selection in attempting to purchase annuities outside of a group, although Jeffrey R. Brown et al. (2000) suggest that private annuity purchasers are receiving nearly fair market rates. 23 Poterba et al. (1998) fraction of workers. A standard life-cycle model would suggest that, aside from tax issues, the form of the pension plan is irrelevant to the worker's retirement security. ...
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... John Beshears, James J. Choi, David Laibson, and Brigitte C. Madrian 5.Poterba, Venti, and Wise (1998) report that the probability that a cash distribution is rolled over into an IRA or another employer's savings plan is only 5 to 16 percent for distributions of less than $5,000. The overall probability that a cash distribution is rolled over into an IRA or another employer's savings plan or invested in some other savings vehicle is slightly higher at 14 to 33 percent. ...
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... Because returns are now random, the projected value of 401(k) balances at retirement will differ across projections, depending on the random returns that happen to be Source: Authors' calculations as described in the text. Results for universal 401(k) participation are the same as those in Poterba, Venti, and Wise (1998a). drawn in a given projection. ...
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This paper presents new evidence on the potential importance of 401(K) assets in contributing to the retirement resources of future retirees. We use data on past 401(k) participation rates by age and imcome decile, along with information on average 401(k) contribution rates, to project the future 401(k) contribution trajectories of households that are currently headed by individuals between the ages of 29 and 39. We allow for the possibility of pre-retirmenet withdrawal of 401(k) assets when individuals experience employment transistion. By combining data from the Health and Retirement Survye on the likelihood of 'cashing out' a 401(k) account conditional on a job change, with data from other sources on the probability of job change, it is possible to estimate the prospective pre-retirement 'leakage' from 401(k) accounts. Our central findings are that for households reaching retirement age between 2025 and 2035, 401(k) balances are likely to be a much more important factor in financial preparation for retirement than they are today. We estimate that average 401(k) balances in 2025 will be between five and ten times as large as they are today, and would represent one-half to twice Social Security wealth (depending on investment allocation and based on current Social Security provisions). For persons retiring in 2035 we estimate that 401(k) balances will be three-quarters to two and one-half times Social Security wealth. Moreover, we find that pre-retirement withdrawals have a small effect on the balance in 401(k) accounts. We estimate that these withdrawals typically reduce average 401(k) assets at age 65 by about five percent. This is largely because most households who are eligible for a lump sum distribution when they change jobs choose to keep their accumulated 401(k) assets in the retirement saving system. These households either leave their assets in their previous employer's 401(k) plan, or they roll the assets over to another retirement saving account, such as a new 401(k) or an Individual Retirement Account. Most of those who do withdraw assets have very small accumulated balances. By comparison, the expense ratio charged by the financial institutions administering 401(k) accounts has a larger effect on retirement resources than the possibility of pre-retirement withdrawal.
... Bivariate tabulations from the 1993 CPS (Korczyk, 1996;Yakoboski, 1994) indicate that women, younger workers, recipients of small distributions, recipients with less than a college education, and recipients with lower earnings are more likely to use lump-sum distributions for nonretirement purposes. A greater propensity to spend among younger workers, less educated workers, and recipients of smaller sums is also supported by multivariate analysis of Health and Retirement Study (HRS) data (Poterba, Venti, & Wise, 1998); however, their analysis assumes no differences by gender, marital status, or characteristics of previous or next job. The fact that many of these characteristics that predict a failure to save are more typical of women than of men raises an interesting question: How do women's and men's behavior compare under similar circumstances? ...
Article
As responsibility for financial security in retirement becomes more individualized, understanding the distribution and determinants of savings behavior grows in importance. Employed men and women often gain access to their pension assets when they change jobs. In this study gender differences in pre-retirement access to and disposition of accumulated pension assets are examined. The authors used data from the Health and Retirement Study to model pension participation, disposition of pension assets, and use of cash settlements derived from a pension plan in a previous job. Logit models provided estimates of gender differences in access to pensions and the preservation of pension funds for retirement. Women were less likely to have participated in employer-sponsored pension plans; more likely to cash out accumulated pension assets when they changed jobs; and, when job changes occurred at relatively young ages, equally likely to spend the settlement. However, by their late 40s, women were more likely to save the settlement, a net gender difference that increased with age at which the settlement was received. The structure of employment compensation continues to place women at a disadvantage. Gender differences in earnings and fringe benefits not only affect current financial status, but also cast a shadow over future financial security. Although the gender gap in pension coverage has been reduced, women with pensions have access to lower benefits and less in accumulated assets. As these continuing deficits are addressed, enhancing women's tendency to save pension assets for retirement can help them build financial security.
... Even without the input from such a distributional comparison, we are aware that there are many ways in which our algorithm for computing retirement wealth could be extended and improved. For example, we do not allow for lump sum distributions from DC plans, even though Engelhardt (2002) and Poterba, Venti, and Wise (1998) suggest that these distributions exert a potentially important drag on retirement wealth accumulation. We have not allowed for differences in asset allocation patterns as a function of individual characteristics, such as education, even though past research such as Ameriks and Zeldes (2004) suggests that there are such differences. ...
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The private pension structure in the United States, once dominated by defined benefit (DB) plans, is currently divided between defined contribution (DC) and DB plans. Wealth accumulation in DC plans depends on the participant's contribution behavior and on financial market returns, while accumulation in DB plans is sensitive to a participant's labor market experience and to plan parameters. This paper simulates the distribution of retirement wealth under representative DB and DC plans. It uses data from the Health and Retirement Study (HRS) to explore how asset returns, earnings histories, and retirement plan characteristics contribute to the variation in retirement wealth outcomes. We simulate DC plan accumulation by randomly assigning individuals a share of wages that they and their employer contribute to the plan. We consider several possible asset allocation strategies, with asset returns drawn from the historical return distribution. Our DB plan simulations draw earnings histories from the HRS, and randomly assign each individual a pension plan drawn from a sample of large private and public defined benefit plans. The simulations yield distributions of both DC and DB wealth at retirement. Average retirement wealth accruals under current DC plans exceed average accruals under private sector DB plans, although DC plans are also more likely to generate very low retirement wealth outcomes. The comparison of current DC plans with more generous public sector DB plans is less definitive, because public sector DB plans are more generous on average than their private sector counterparts.
... Given the impact of taxes imposed on pre-retirement withdrawals and missing out on the benefits of compounding of returns over future time periods, it is assumed that "good quality advice" would in most instances be to preserve funds controlling for other factors playing a role in the decision, as identified in previous studies, where it has been found that those who are older, with higher incomes, who are more educated and who are married, are more likely to preserve funds (e.g. Bassett, Fleming & Rodrigues 1998;Moore & Muller 2002;Poterba, Venti & Wise 1998). Therefore understanding whether those with low levels of financial literacy seek assistance in this situation, and, if they do, whether they receive good advice, would provide additional insights into the relationship between financial literacy and advice. ...
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... While a fairly extensive literature has analyzed employee participation and contribution decisions with regard to ESPs, considerably less attention has been given to pre-retirement withdrawal decisions. Much of the prior research on withdrawals has analyzed the influence of basic household and plan characteristics (Andrews, 1991;Bassett et al., 1998;Purcell, 2002;Poterba et al., 1998;Sabelhaus and Weiner, 1999). From this literature a number of stylized facts about early withdrawals has emerged. ...
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This study uses the National Survey of Youth (NLSY79) to inves- tigate the role of liquidity constraints and income risk on the decision of workers to take money from their employer-sponsored retirement plan when leaving a job. The results show that workers who faced an unemployment spell at job separation were roughly 15 percent more likely to withdraw money from their plans than those who do not. This nding
... Measurement should cover all three stages because a narrow focus on one or two stages would miss some facets of behavior. For example, when workers in the United States switch jobs, about half of them cash-out their employeedirected retirement savings (Samwick and Skinner, 1997;Poterba, Venti, and Wise, 1995). What does this mean for saving? ...
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... A number of recent studies have found that when ESP assets become available upon leaving a job, many individuals cash out the accounts and spend the assets, rather than rolling them over to another TDA. 3 This result is particularly prevalent among households with low levels of ESP assets. Engelhardt (2002) and Poterba, Venti, and Wise (1995 Wise ( , 1999) find that the aggregate size of these cash–outs are small, i.e., a majority of assets in dollar terms are preserved in TDA form. Nevertheless, there is a certain sense of alarm that precisely those households that are worst prepared for retirement end up raiding their pension savings when given a chance. ...
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... •! Rollovers of LSDs increase with age, income, and size of distributions (Andrews 1991;Burman, et al. 1999;Chang 1996;Fernandez 1992;Hurd, et al. 1998, Korczyk 1996Poterba, et al. 1998;Sabelhaus and Weiner 1999;Scott andShoven 1996, Yakoboski 1997) •! Early withdrawals from IRAs and employer-sponsored plans are often associated with adverse shocks (Amromin & Smith 2003;Lin 2006) •! Some cash outs used for "savings" in a broad sense -invested in a taxable account, used to buy a business or home, or used to pay down debt (Burman, et al. 1999) Some Results from Retirement Research continued •! Among employees terminating after age 60, most rollover assets to an IRA within 5 years (Utkus and Young, 2010) •! ...
... Households that cash out their LSDs potentially sacrifice future retirement income in 1 See Andrews (1991), Burman, Coe, and Gale (1999), Chang (1996), Engelhardt (1999), Fernandez (1992, Gustman and Steinmeier (1998), Hurd, Lillard and Panis (1998), Korczyk (1996), Poterba, Venti, and Wise (1998, 1999), Sabelhaus and Weiner (1999), Scott and Shoven (1996), and Yakoboski (1997). exchange for current expenditures, and these households share characteristics with households who appear to save too little for retirement and with those for whom participation in pensions is most likely to generate net increases in wealth. ...
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