When Two Policies Collide — What Should 401(k) Plan Sponsors Do About Retirees?

When retirees leave their money in their old company’s 401(k), it can increase costs and liabilities for the plan. So what should be done? Education on the benefits of IRA rollovers would be a good start.

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A quick read of the recent Department of Labor (DOL) fiduciary rules would lead one to believe that the department is against people rolling their money out of a company 401(k) when they retire or leave the company. A deeper read into the rules reveals that they want retirees to be informed of their choices.

Basically, they have four options: 1. Leave the money in the plan. 2. Cash the money out of the plan. 3. Roll the money into another company plan (if they are going to work for another company). 4. Roll the money into an IRA.

What they decide to do not only affects themselves, it can also affect the company — and not necessarily in a good way.

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Plan Sponsor's Perspective

The plan sponsor must look at the big picture, the whole plan. Many of the fees charged to a plan are on a per-participant basis. So the more participants, the higher the fees. So, it would seem logical, you may want to reduce the number of participants to reduce fees.

Because they are no longer producing value for a company, retirees can be seen as an unnecessary expense. They are also a liability to the plan. While it is true that all the other participants in the plan are also liabilities, that is offset by the fact that they are also active employees, assets to the company. The liability is offset by their value to the company. Retirees no longer work at the company, so they are no longer assets.

One of the primary responsibilities of plan sponsors is to manage/reduce the risks. As a liability to the plan, retirees raise risks immeasurably. If plan sponsors are responsible for how a participant manages his money, which he is because he is a fiduciary, then it is logical to assume the plan sponsor is also responsible for how a retiree who has left his assets in the plan manages his money.

This means that, in essence, the plan sponsor is responsible for the lifetime income of that retiree. How much of a risk is that? Immeasurable. It is an unlimited risk. If the job of the plan sponsor is to reduce or manage risks to the plan, how does he manage an unlimited risk? The plan sponsor needs to reduce the liabilities, and that means aiming for retirees to roll their assets out of the plan.

Retirees' Perspective

From a retiree’s perspective, why would you want to stay? Your access to funds is limited, your choices of investments are limited, and you have very little control over costs and portfolio management.

Here are the choices of the retiree:

1. Stay in the plan. As discussed above, limits are the key negative. However, fees may be low due to the structure of the plan. Fees however may be the only positive vs. a mountain of negatives to staying in the plan. (Emotional attachment may be the reason many people stay, but from a financial/retirement planning perspective, it is the least valid reason.)

2. Cash out of the plan. This is an option for those who do not want to stay in a tax-deferred vehicle and would rather pay gobs of taxes right away. If you do not mind seeing taxes cut your nest egg by as much as 50% or more, this option is viable. It is not highly recommended.

3. Roll to another company plan. If you are switching jobs, and not retiring, then this is a viable option. Depending on the new company's plan, you may have similar investment options and similar costs.

4. Roll over to an IRA. This gives the retiree the greatest amount of freedom. Unlimited investment, strategy and cost options. The retiree can hire his own personal financial planner, money manager or investment adviser. The retiree can run the money himself. The retiree may be able to utilize investments not available within the company plan. The retiree can get personalized services and advice, and not have limits as to when he withdraws money or how much he withdraws.

From the retiree’s perspective, the main reason for staying in a company plan would be costs. However, when weighed against all the positives a retiree benefits from by rolling his money into an IRA, it is hard to justify staying in the company plan. It can be pennywise and dollar foolish.

The Best of Both Worlds

From the plan sponsor's perspective, he must consider the greater good for all. And the needs of the many other participants in the plan far outweigh the needs of the single retiree. It is incumbent on the plan sponsor to have regularly scheduled exit seminars to educate the retirees on their options before they leave the company.

When only viewed from the cost perspective, staying in a company plan may be the right option for the retiree. But the plan sponsor's responsibility to the other participants, and the benefits a retiree receives by rolling over to an IRA far outweigh the cost issue.

In this case it is clear, when these two policies collide, it is better for the plan sponsor, the plan itself and the retiree for the plan sponsor to have regularly scheduled retirement seminars for employees close to retirement and, in many cases, for retirees to roll their assets over into an IRA.

Disclosure: Third-party posts do not reflect the views of Cantella & Co Inc. or Cornerstone Investment Services, LLC. Any links to third party sites are believed to be reliable but have not been independently reviewed by Cantella & Co. Inc or Cornerstone Investment Services, LLC. Securities offered through Cantella & Co. Inc., Member FINRA/SIPC. Advisory Services offered through Cornerstone Investment Services, LLC's RIA. Please refer to my website for states in which I am registered.


This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

John Riley, AIF
Chief Strategist, Cornerstone Investment Services

In 1999, John Riley established Cornerstone Investment Services to offer investors an alternative to Wall Street. He is unique among financial advisers for having passed the Series 86 and 87 exams to become a registered Research Analyst. Since breaking free of the crowd, John has been able to manage clients' money in a way that prepares them for the trends he sees in the markets and the surprises Wall Street misses.