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Plan Distributions: Should I Stay or Should I Go?

By Jeb Graham, CEBS, CIMA® Accredited Investment Fiduciary®, of CapTrust Financial Advisors, an independent consulting/advisory practice focused on the institutional retirement plan market, serving corporate, closely held, non-profit and governmental organizations. You may contact Jeb at 813.218.5008 or jeb.graham@captrustadv.com.


Many of us who date back to the advent of 401k plans can remember a song from that era by The Clash, "Should I Stay or Should I Go?" It is unlikely any of us 401k pioneers, even in our wildest dreams, could have made a connection to plan distributions. So, hang with me on this.

Plan sponsors must establish how and when distributions will be made to participants. There are several factors playing into the decision, including size of the plan, number of terminated participants, turnover frequency, rehire policy, forfeiture reallocation provisions and, perhaps most significant of all, the employer's culture. A paternalistic employer is more likely to consider ramifications beyond simply getting participants paid as quickly as possible.

In the past, plan sponsors have generally been proactive in paying terminated participants out, getting them off the books, sooner rather than later. The standard distribution option in most DC plans has been lump sum. Most benefit payments to terminated participants typically were small, frequently less than $10,000, so there was little or no impact on the growth of plan assets. The thinking at the employer level was to encourage participants to take their distribution, thereby removing them as a drag on plan administration costs which are directly related to participant counts.

In particular, plans with high turnover could meaningfully reduce their administrative burden by operationally managing their terminated participant accounts. Removing these small participant accounts lowered costs and served to increase the average account balance across the plan. Historically, plans with higher average account balances had proportionately lower plan administration costs.

Another positive result of accelerating distribution is the impact on forfeitures. Since most terminated participants were not fully vested, benefit payments created forfeitures to be either reallocated to remaining participants or to offset plan costs. Also, for smaller employers, keeping participant counts below 120 would allow them to avoid the additional cost and effort related to mandated plan audits filed with the Form 5500.

More Paternalistic

In the past five years, there appears to be a trend toward plan sponsors adopting a more paternalistic approach with regard to distribution policies and really looking out for the best interest of their employees.

Plan sponsors with more than 200 employees are likely to be on an investment platform with institutional share classes of mutual funds, hence lower expense ratios. In comparing alternatives, it may be in the best interest of participants to stay in the plan in a more diversified portfolio with lower expense investments. Many plans offer a pooled, stable value option with a fixed rate of return. Stable value funds are not available to individual investors; an important consideration for participants with a conservative bias.

For a participant upon termination or approaching retirement, the alternative to keeping their account balance in the plan is an IRA rollover. Most mutual fund, bank or insurance company IRAs use retail share classes with higher expense ratios than what might be offered in a DC plan. Many such investments still have front-end loads. Participants with larger balances may be enticed to a self-directed IRA rollover offered by a bank or brokerage firm. A potential downside with these accounts is a wrap fee of 1% or more on top of the mutual fund expenses or custodial fees.

A potential pitfall facing the participant with a smaller account balance is the high expense, variable annuity product. With firms across the brokerage industry raising the threshold for minimum revenues generated by financial advisors, the account size at which advisors can/will offer advice increases. Thus, participants with smaller account balances often end up on the wrong end of an annuity product, paying a large front-end commission to a broker with little ongoing consultation after the sale.

From the standpoint of investment expenses, participants are almost always better off staying in the DC plan portfolio. Assuming the same investment, lower expenses translate into increased returns. An additional consideration is that, if a plan sponsor is using an independent investment advisor to provide fiduciary services, the DC plan portfolio is probably being very closely monitored to hold "best-in-class" investments, in comparison to an individual retail account at a bank or brokerage firm that does not fall under ERISA fiduciary rules. From the standpoint of these fiduciary obligations, and given the factors mentioned, it is likely the beginning of a trend in which plan sponsors are also better off keeping participants in the DC plan.

Dollars and Sense

As DC plans have matured, it is becoming much more common for retiring or terminating non-executive employees to have account balances in the $50,000 - $200,000 range. With more baby boomers reaching retirement age, this presents a challenge for plan sponsors because larger distributions to a greater number of participants may result in net negative cash flow for their DC plans.

In the past, most DC plans experienced net positive flows as aggregate contributions plus earnings almost always exceeded aggregate distributions, thus plan assets grew each year. As assets grew, asset-based expenses decreased producing a more favorable result for plan participants. Going forward, this may reverse as more participants take larger distributions. Negative cash flows could potentially result in an overall fee increase to the plan.


In my opinion, the answer to the song is STAY. Both plan sponsors and participants are likely to be well-served if plan assets are retained in the plan beyond retirement or separation from service. Participants benefit from fiduciary oversight of an ERISA plan and lower expenses. Plan sponsors looking to act in the collective best interests of participants should opt for portfolios with professional, independent oversight with fee transparency. In the end, it is likely that STAY = win/win for both plan sponsors and participants.

And by the way, if you have never heard the song, Google it and listen…it's an 80's classic.

This material is distributed solely for informational purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. The views contained herein are the opinions of the author. It is not intended as legal or tax advice.

CapTrust Advisors, LLC is a Registered Investment Advisor with the SEC. CapTrust is not a legal or tax advisor.


401khelpcenter.com is not affiliated with the author of this article nor responsible for its content. The opinions expressed here are those of the author and do not necessarily reflect the positions of 401khelpcenter.com. This article is for informational and educational purposes only and doesn't constitute legal, tax or investment advise.

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