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Retirement Planning > Saving for Retirement

Why Social Security 'Bridge Accounts' Make Sense: Blanchett

By John Manganaro

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What You Need to Know

  • Most DC plan participants would benefit from waiting to claim Social Security, but few delay until age 70.
  • David Blanchett suggests having a sleeve of savings in 401(k) accounts set aside to bridge the gap between leaving the workforce and claiming benefits.
  • Such an approach would result in a flexible pool of assets and would precondition workers to delay claiming, he says.

The defined contribution retirement plan system in the United States is a powerful wealth-creation vehicle for middle-class and mass affluent Americans. Yet despite decades of diligent saving, the relative complexity of creating sustainable retirement income from accumulated assets and the related challenge of optimizing Social Security claiming mean many people achieve suboptimal outcomes in retirement.

This is one of the conclusions drawn in a recent paper published by David Blanchett, managing director and head of retirement research at PGIM DC Solutions. The paper explores the potential benefits of delayed claiming of Social Security “from a DC plan perspective.”

According to Blanchett, the analysis suggests that the average retiree, and especially the average DC participant, would likely benefit from delayed claiming. However, relatively few retirees fully delay to age 70 or appear to have the financial means to do so when focusing on retirement plan balances alone.

Therefore, Blanchett argues, increasing awareness of the benefits of delayed claiming to DC plan participants is important for industry professionals and policymakers — as is ensuring that participants have considered the strategy as they contemplate allocating potentially limited assets to an alternative lifetime income solution, such as an annuity.

The paper points to one approach to potentially improve claiming behaviors: “preconditioning” participants by creating a “bridge account” within the DC plan’s default investment specifically earmarked to fund spending during the delay period. Overall, Blanchett says, the work suggests that delayed claiming needs to be more proactively considered among DC plan sponsors and participants.

How a Bridge Would Work

The crux of Blanchett’s argument is the creation of an overtly labeled “delayed claiming account” sleeve within a given DC plan, ideally within the default investment itself, which is typically a target-date fund or a managed account.

“The bridge sleeve (or account) would be used to bridge the income gap during the delay period and would generally be expected to be invested in relatively liquid securities,” Blanchett explains.

These securities could include primarily defensively minded fixed income investments, but they could also include more limited amounts of equities and alternatives to support additional growth, depending on the plan population or individual being considered.

According to Blanchett, having a sleeve explicitly geared toward delayed claiming would not only behaviorally prepare participants to delay claiming but would also result in a significantly higher level of flexibility than strategies that require a higher level of commitment, from both participants and plan sponsors.

“While the monies in the ‘delayed claiming account’ sleeve could (or ideally would) be used to fund delaying Social Security, they could also be used to purchase a different type of annuity or not annuitize at all. There is significant optionality to the savings,” Blanchett concludes.

Beyond 401(k)s

In comments about this and other recent analytical work shared with ThinkAdvisor via email, Blanchett emphasizes that 401(k)s are a “great place to save for retirement” but that it is also important to keep DC-based saving in its broader context. For example, if a worker is fresh out of school with lots of debt and other pressing financial needs, there might be better uses for money.

“I think it’s really important to always try to save some in a 401(k), especially up to the employer match,” Blanchett says. “Beyond that, it might make more sense to use the savings for other things that could be more important for someone, like paying down student loan debt, paying off credit card debt or saving for a house. It’s okay to not be saving much for retirement if you’re putting money to good use in other places.”

Blanchett also points out that modern 401(k) plans tend to use a lot of defaults and automatic behaviors. That’s a good foundation overall, he says, putting inertia to work for savers rather than against them, but leaving things on autopilot can also have its downsides.

“Lots of 401(k) plans have defaults, in particular around default investment and default savings rates,” he explains. “The default investment, which is typically a target-date fund, is typically a great way to invest. The default savings rate, though, might not be the smartest choice.”

Default savings rates are often 6% or lower, which is typically not going to be a high enough savings rate to achieve a successful retirement. Blanchett says a combined employer and employee contribution of at least 12% of pay is a better target for middle-class and mass affluent workers who don’t expect Social Security to cover the majority of their spending needs in retirement.

Other DC Plan Questions

With respect to other financial planning considerations affecting DC plan participants, Blanchett says saving pre-tax in a traditional 401(k) or individual retirement account is probably the smart move for most people.

The other option, of course, is to fund a Roth account with after-tax money.

“Most people who are working are going to have a higher marginal tax rate when they’re working, so saving pre-tax is typically going to be the smart move,” Blanchett says. “But it really depends on each person’s facts and circumstances. One important point is that any employer contribution is effectively going to be pre-tax (fully taxed upon distribution) so saving at least a little bit in a Roth is a way to create some ‘tax diversification’ in your savings.”

Blanchett’s last point: Clients should think twice before rolling out of a 401(k) plan.

“You may have access to unique investments or solutions in your 401(k) plan that are tough (or impossible) to get if you roll the money out of the plan into an IRA,” he warns. “Therefore, before deciding to roll the money out of the plan make sure you have a good reason to do so.”

Pictured: David Blanchett

John Manganaro

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