Defined Contribution Linked to Retiree Poverty

Pre-retirement lump-sum withdrawals and lack of annuitization may push retirees towards financial ruin, according to research.

Defined contribution (DC) plan features correlate with an increased risk of post-retirement poverty, according to an academic paper.

The study—conducted by Natalia Orlova and Matthew Rutledge of the Boston College Center for Retirement Research, and April Wu of Mathematica Policy Research—found retirees with access to liquid assets but without annuity streams face a far greater risk of outliving their savings than those with defined benefit (DB) plans, even controlling for overall income and wealth level. 

“The transition from DB to DC plans will require future retirees to negotiate their way through a minefield of challenging decisions that may reduce retirement income for themselves and their surviving spouses,” the authors wrote.

According to the research, DC provisions such as pre-retirement lump-sum withdrawals and the lack of automatic annuitization increased the likelihood of retirees reaching financial insolvency.

“The transition from DB to DC plans will require future retirees to negotiate their way through a minefield of challenging decisions that may reduce retirement income.” —Orlov, Rutledge,
& Wu
The authors studied more than 2,700 households with members aged 65 to 69 and 75 to 79 and found 80% of DB pension retirees reported receiving annuity income compared with one in five of those with a DC plan.

In addition, 19% of households with only DC plans said they took a lump-sum payout before the age of 55, while only 12% of those with only DB plans withdrew before retirement.

The data also showed these lump-sum payouts were positively correlated with having income below the poverty threshold, as far as 200% below the poverty line.

“These distributions before age 55 are almost certainly not supporting retirement consumption and leakages during these years hurt most because of the lost opportunities to compound the returns,” Orlova, Rutledge, and Wu wrote.

Furthermore, households lacking annuity payments were more likely to dip below 150% or 200% of the poverty line, the paper said. This risk increases even more for widows and widowers ages between 75 and 79, the data showed, as their spouses’ annuity incomes discontinue after death.

Furthermore, the study found links between DC plan characteristics and projected future poverty for retirees aged 65 to 69. Annuity payments, which only 19% of DC members reported receiving, were the most statistically significant indicator of a retirees’ financial stability over a 10-year time horizon. 

“Surprisingly, the type of pension does not appear to matter for the 1928 to 1935 birth cohort in this study, but most of this cohort had access to DC plans only as a supplement to DB income,” the authors wrote. “Workers in future cohorts that rely on non-annuitized DC plans as their sole source of retirement income are likely to be demonstrably worse off.”

Read the full paper: “The Transition from Defined Benefit to Defined Contribution Pensions: Does It Influence Elderly Poverty?”.

Related: American Failure & Why Plan Sponsors Make Bad Plan Designers

By Sage Um

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