Helping Recent Retirees During the Great Resignation

Key Takeaways:

• The Great Resignation includes over 3.5 million individuals age 55 and older who chose to retire in the past two years alone (2020 and 2021). Based on this data, it seems that the Great Resignation may just as easily be described as the Great Retirement.
• Leaving a retirement plan account in a former employer’s plan is the easiest course of action and may make sense if recent retirees are happy with their current investments and plan service-provider.
• Rolling over a retirement plan account to an IRA after retiring is also very common, and depending on facts and circumstances, will often be the best long-term approach.
• Cashing out a retirement plan account when retiring should be avoided, if at all possible.

The COVID-19 pandemic brought about a monumental change in the US labor force, motivating employees of all ages across the country to re-evaluate their pay and their priorities. In doing so, millions of Americans decided to make a change. In fact, the U.S. workforce averaged almost four million resignations a month in 2021 (just over 3.95 million, to be exact), a new annual record¹. This record broke the previous record of 3.5 million that was also set very recently, in 2019.2 Experts expect that trend to continue into 2022, and have already dubbed this current phenomenon as the Great Resignation².

What some may fail to realize about the Great Resignation, however, is that many of those who are resigning are not choosing to go to another job. They are choosing to retire. This should not be shocking, as an average of 10,000 individuals from the Baby Boom generation reach age 65 every day, and will continue to do so through the end of this decade.³ More significantly, the COVID-19 pandemic accelerated Baby Boomers’ retirement plans. As of the third quarter of 2021, 50.3% of U.S. adults age 55 and older were retired.⁴ That is in comparison to 48.1% of adults that same age who were retired in 2019, before the start of the pandemic. For 65-74 year-olds, 66.9% were retired by the third quarter of 2021, versus 64% of adults that same age who were retired in 2019.⁵ In the aggregate, the Great Resignation has added over 3.5 million retirees age 55 and older in the past two years alone.⁶ Based on this data, it seems that the Great Resignation may just as easily be described as the Great Retirement.

When employees retire, those who participate in a defined contribution retirement plan have a decision to make. What should they do with their existing retirement plan account? These recent retirees have three options:

1. Leave the account with their former employer’s plan;
2. Rollover the account into an individual retirement account (IRA); or
3. Cash out the account.

As financial professionals, we must be ready to guide our recent retiree-clients through this very important financial decision. In doing so, it will be important to help them consider their plans for their Golden Years while taking a comprehensive look at their current investments and strategy to make sure they will have the funds they need to finance their retirement years.

Leave the current plan account in place

So long as a retiree’s plan account is at least $5,000, no decision will “have” to be made. By choosing to do nothing, the plan account will remain within their former employer’s plan. For some retirees, this may initially be the easiest course of action, because the choice of what to do with the plan account and what to invest outside of the limited choices in the existing plan can be overwhelming. In certain circumstances, remaining in this static position in their former employer’s plan and staying the course may be a perfectly reasonable choice.

For instance, if a client retires from an employer who sponsors a large 401(k) plan with hundreds of millions of employee dollars to invest, that plan will have access to certain types of low-cost investments (e.g., stable value funds and other institutional-class funds) that are not always available elsewhere. In addition, these low-cost investment options should be regularly vetted by the plan’s fiduciaries, which may give retirees additional peace of mind that their investments are relatively safe. Some large employer plans may even provide advice and cover advisory fees; an added bonus! In this instance, a retiree may be quite satisfied with the current investments and service provider. But if circumstances change down the road, the retiree is always free to choose to rollover their plan account into an IRA at a later time, even years after they retire.

However, be aware that sometimes these large employers may charge former employees higher administrative and maintenance fees than what they charge their current employees. That is something to look out for and take into consideration when deciding whether to leave an existing plan account with a former employer’s plan. In addition, be warned that the converse situation to that described in the previous paragraph is also common. For a client who retires from an employer who sponsors a smaller retirement plan, that small plan’s fees may be relatively higher because smaller plans have a harder time achieving economies of scale. In that instance, a retiree may find lower fees by rolling their retirement plan account over into an IRA.

Rollover the plan account into an IRA

Aside from the potentially lower management and administrative costs in comparison to many smaller defined contribution retirement plans, one other significant factor that may lead retirees to rollover their retirement plan account into an IRA is choice! Investment options in an IRA are essentially limitless. Retirees can invest in any mutual fund, individual stock, and other investment opportunities. For example, although most defined contribution retirement plans have a solid line-up of stock funds, they may be weaker when it comes to fixed-income options, and many retirees may benefit from certain bond funds they cannot find in most defined contribution plans’ fund line-ups. Or perhaps a retiree wants to hedge against longevity and purchase a guaranteed lifetime income product (i.e., an annuity), which is an investment option that at least for now remains uncommon in most defined contribution retirement plans. For those retirees with a bit more investment experience and sophistication, using an IRA to invest in these options, or even real estate, is a possibility. These types of investments are often not possible through a defined contribution plan account.

Another benefit of rolling over an account from a former employer’s retirement plan is the ability to consolidate retirement accounts. Many retirees find that combining retirement savings all in one place makes it easier to manage their money and track their progress. This is particularly true for retirees who have worked for multiple employers throughout their careers. In fact, individuals born in the latter years of the Baby Boom (1957-1964) held an average of 12.4 jobs from ages 18 to 54!⁷ If a retiree has a lot of different defined contribution retirement plan accounts floating around out there with various former employers, the risk is greater that in the aggregate there is a jumble of overlapping funds that may no longer align with their age and risk tolerance.

Once a retiree consolidates their defined contribution retirement plan accounts into an IRA, they also have better control over partial distributions. For one thing, many defined contribution plans do not even permit partial distributions; instead requiring an “all or nothing” choice, thereby requiring retiring participants to decide whether to leave their entire balance in the plan or take a total distribution of the entire amount (either as a cash distribution or as a rollover). Of those defined contribution plans that do allow for partial distributions of less than the entire account balance, those partial distributions are almost always going to be pro-rata from both all plan investments and all plan sub-accounts. So for instance, if a retiree takes a partial distribution from their IRA, they can specify which particular investments to sell, and leave the rest of their money in the fund of their choosing.
Finally, rolling over defined contribution retirement plan accounts into an IRA can offer several possible tax-planning strategies:

• Roth IRAs – If a retiree’s defined contribution retirement plan account contains Roth subaccounts, rolling those Roth amounts into a Roth IRA will shield them from required minimum distributions (RMDs). Roth amounts that remain in retirement plans are subject to RMD rules.
• Backdoor Roth Conversions – If a retiree has after-tax amounts in their defined contribution retirement plan account, then they can roll over after-tax amounts into a Roth IRA in what is known as a “backdoor Roth conversion.” This allows those retirees to shield future investment growth on those after-tax amounts from taxation. This tax-planning technique is important to consider because proposed changes to tax law could take this opportunity away in the near future.
• Avoid Automatic Withholding – The IRS requires an automatic 20% withholding on distributions from defined contribution retirement plans, even partial distributions. There is no similar requirement that federal taxes be withheld from IRA distributions.⁸ This allows retirees to take out only what they need and allow the rest of their retirement dollars to stay in the IRA and keep compounding.
• Income and Estate Tax Planning – Although rules vary from plan to plan, most defined contribution retirement plans try to cash out the account of a deceased participant quickly in a single lump sum paid to the listed beneficiary so that the plan sponsor does not have to maintain control and continue administering an account for a deceased participant. Depending on the income level and net worth of retirees, this may cause both income and estate tax headaches. Although inheriting an IRA also has tax implications, IRAs offer more payout options and flexibility, with at least a 10 year period over which to take distributions depending on the beneficiary’s age and relationship to the IRA owner.

Cash out their plan account

The last option to consider for those who are retiring is often the least likely to be appropriate. This is because if a retiree cashes out their entire retirement plan account, then the total pre-tax amount within that account will be subject to federal income tax as well as state income tax, depending on the retiree’s state of residence. Taking a single lump sum at one time may also bump the retiree up into a higher tax bracket in the year of the cash out, subjecting the retirement income to an even higher tax rate than if they took smaller distributions over the course of their (hopefully) many years of retirement. Furthermore, once the plan balance is cashed out, it will be more readily available for the retiree to spend, and chances then increase that the amount will be spent well before the end of the retiree’s life. For those reasons, a total lump sum cash out of an individual’s defined contribution plan account upon the start of their retirement should be avoided in most circumstances.

Conclusion

Thinking about and approaching retirement is an exciting time for clients. Yet it also presents them with important financial decisions to make that can also cause a great deal of stress and anxiety. Being able to help clients approaching retirement evaluate their future goals while taking into account their financial health and current investments to help them choose the best of the options described above is critically important. It will help to ease their mind and nurture an ongoing client relationship. In this endeavor, Nationwide Financial remains by your side, to help you and your clients prepare for a Great Retirement.