The COVID-19 pandemic brought about a monumental change in the U.S. 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 4 million resignations a month in 2021 (just over 3.95 million, to be exact), a new annual record.1 This record broke the previous record of 3.5 million, which was set in 2019.2 Experts expect that trend to continue into 2023 and have already dubbed this current phenomenon as the Great Resignation.
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.2 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.3 That is over 2% higher than the 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, almost 3% higher than the 64% of adults that same age who were retired in 2019.3 In the aggregate, the Great Resignation has added over 3.5 million retirees age 55 and older in the past 2 years alone.3 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 3 options:
- Leave the account with their former employer's plan
- Roll over the account into an individual retirement account (IRA)
- Cash out the account
Leave the current plan account in place
As long as a retiree’s plan account contains at least $5,000, no decision is required 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 in 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.
Roll over 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 roll over 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 or other investment opportunity. For example, although most defined contribution retirement plans have a solid lineup 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 lineups. Or perhaps a retiree wants to hedge against longevity and purchase an investment option such as a guaranteed lifetime income product (i.e. a target date fund with an annuity component). 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. It is particularly true for retirees who have worked for multiple employers throughout their career.
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 lump-sum 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.
Thinking about and approaching retirement is an exciting time for participants. 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 participants approaching retirement to 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.