Many 401(k) Participants Have No Idea How Cash Will Come Out

What You Need to Know

Olivia Mitchell is a Wharton economist who has published many papers on annuities and retirement.
Defined benefit plan participants are much more likely to be offered annuitized benefits.
Participants with higher financial literacy scores are more likely to choose annuitized benefits.

Nearly half of the older participants in 401(k) plans and other types of defined contribution plans have no idea how they will get cash out of their accounts.

Even some defined contribution plan participants who have taken distributions cannot say whether they took the distributions in the form of lump-sum payments or in the form of a stream of annuity benefits.

Two researchers, Robert Clark and Olivia Mitchell, have included data on the limits of plan participants’ knowledge in a new working paper, based on 2020 survey data, on the factors influencing the choice of pension distribution options at retirement.

What It Means

Some of your clients and prospects may just be pretending to know what kinds of retirement benefits they have, or don’t have.

Make sure they understand the basics before starting to analyze their needs.

The Study

Clark is a management professor at North Carolina State University in Raleigh.

Mitchell is a Wharton School economist who has published many papers about annuities, retirement planning and related topics.

Clark and Mitchell have published their new working paper, behind a paywall, on the website of the National Bureau of Economic Research. A working paper is an academic research paper that has not yet gone through a complete academic peer review process.

The researchers based the paper on a module in the University of Southern California’s Understanding America Study online survey program.

One part of the module was a financial literacy quiz, which included questions about how interest rates, inflation and rate compounding work.

The module attracted 2,510 U.S. people ages 45 through 75, including 867 people who said they had received distributions from their plans; 882 who said they expected to receive money or payments from employer-provided pension plans or retirement accounts in the future; and 88 who did not know whether they would receive pension or defined contribution retirement plan benefits.

The Meat

Defined benefit plans are much more likely than defined contribution plans to offer participants a lifetime annuitization option as the default cash distribution option.

Partly as a result of that difference, defined benefit plan participants were much more likely than other defined contribution plan participants to have received annuitized benefits, and to expect to receive annuitized benefits in the future.

About 71% of the pension plan participants had already received annuitized distributions, and about 77% said they expected to receive annuitized benefits in the future.

Only 12% of the defined contribution plan participants said they had received annuitized benefits, and just 7.7% said they expected to receive annuitized benefits in the future.

Participants who were older, had higher incomes and performed better on the financial literacy quiz were more likely to choose annuitized benefits.

The Knowledge Gaps

When analyzing the data, Clark and Mitchell had to adjust for the fact that many of the survey participants were not sure whether they had retirement benefits, or how any retirement benefits they had worked.

About 5.5% of the survey-takers could not say whether they could expect to receive retirement benefits.

And 9.9% said they expected to receive retirement benefits, but said they were not sure whether the benefits would be coming from a defined benefit pension plan or a defined contribution plan.

Almost 15% of the survey-takers said they had already received distributions but were not sure what type of plan the distributions had come from.

Confusion about distributions already received was especially severe for participants in defined contribution plans.

Only 3.5% of the defined benefit pension plan participants were unable to say whether they had taken distributions in the form of annuitized benefits or lump sums.

More than 17% of the defined contribution plan participants who had received distributions did not know whether the distributions were in the form of annuitized payment streams or lump sums.

Similarly, 5.6% of the survey-takers who were in defined benefit pensions and expecting to get benefits in the future could not say what form the benefits distributions would take.

About 46% of the survey-takers who were expecting to get defined contribution plan benefits in the future did not know how the benefits distributions would arrive.

Survey-takers with higher financial literacy scores were much more likely to know what kind of plan they had and how cash was likely to come out.

Clark and Mitchell’s Assessment

Clark and Mitchell say the survey results show that how plan sponsors explain annuitized benefits has a big effect on how likely participants are to annuitize.

The results also show the importance of financial literacy for retirement decisions, the researchers say.

“Individuals without basic knowledge of plan provisions are unlikely to make optional decisions concerning the distribution of their retirement assets,” the researchers warn.