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Retirement Income Options Can Pose Tradeoffs for 401(k) Plan Participants

GAO-16-433, August 2016

American workers are primarily saving for retirement through their 401(k) plans and most will likely need assistance making complicated decisions about how to use their savings throughout retirement. A number of options may be available within a 401(k) plan. This interactive model illustrates the possible tradeoffs of four options that can help retirees secure monthly income beginning at retirement:

  • Withdrawing a set dollar amount;
  • Withdrawing a percentage of the 401(k) account balance;
  • Withdrawing amounts based on the 401(k) account balance and the account owner's life expectancy—referred to here as an "RMD-based" (Required Minimum Distribution) withdrawal method; and
  • Purchasing a fixed immediate income annuity—an insurance product that provides guaranteed retirement income for the life of the insured.

This model also illustrates how different factors can affect retirement income, including retirement age, as well as factors that retirees may not be able to control, such as interest rates and investment returns.

To use the tool, select all the retirement profile choices in order. Once the profile is complete the chart will automatically populate. Place your cursor over the plotted areas on the graph to show more detailed information below the graph.

Complete the profile at retirement:
Gender: Gender affects retirement income planning because women tend to live longer than men; therefore, they are likely to draw a greater number of payments over their lifetimes. One effect is that, where insurers are allowed to take this difference into account, women generally receive lower periodic payments from the annuity than men receive for a given dollar amount spent on the annuity purchased. Annuities offered inside a 401(k) plan would not differentiate pricing by gender; however, this model calibrated annuity pricing to the retail market, where gender-distinct pricing is allowed.

Age at retirement: Illustrations are based on key Social Security claiming ages. Age 62 is the age at which participants are first allowed to claim retirement benefits; age 66 is full retirement age for people aged 61 to 73 in 2016; and age 70 is the latest age at which Social Security benefits are increased for delayed retirement. By delaying retirement income withdrawals, retirees can expect to receive higher payments. Retirees can also increase the likelihood that their savings will last throughout retirement if they start withdrawals later.

401(k) balance at retirement: The 401(k) account balance at retirement is used to purchase a fixed immediate annuity at retirement and as the starting balance for withdrawal options. After retirement begins, the balance is adjusted for withdrawals and the investment return selected below to determine the availability of funds for future withdrawals.

Select key assumptions:
Inflation-adjusted monthly retirement income*

*The projected income illustrated in this model has been discounted to its value at the assumed retirement age for assumed annual inflation of 2.25 percent.

Disclaimers: This model should only be used for illustration purposes and does not represent any specific annuity quotes or rates from insurers or other financial institutions, nor does it include many of the individual circumstances that may be considered. Moreover, conclusions drawn from the use of this model should not be taken as an endorsement or financial advice about retirement income options available in 401(k) plans.

The 401(k) account balance options modeled here are for illustrative purposes only, and are not intended to represent actual account balances held by 401(k) plan participants as of publication. As such, the amount of income illustrated by this model also should not be considered to represent what 401(k) participants could generate with their savings as of publication.

Notes: This retirement model simplifies the many factors and options that 401(k) plan participants can consider to obtain lifetime income in retirement. For example, the model does not take into account a 401(k) participant’s access to other sources of retirement income, such as Social Security and other personal savings, which can affect the choices a participant makes for using their assets. The model also does not consider the tax implications of various retirement income strategies.

401(k) plans generally offer participants only one distribution option, a lump sum payment. Some 401(k) plans may offer other options to participants, but most plans in our review did not offer annuities or withdrawal options. According to our non-generalizable questionnaire responses from 401(k) plan record keepers, about a third of plans offered a withdrawal option, and about a quarter offered an annuity option (for details, see GAO-16-433).

We simulated retail annuity prices where the annuity payment differs by gender. Annuities offered inside a 401(k) plan would not differentiate pricing by gender and may be rated differently than retail annuities. The annuity payments represented here are for illustrative purposes only and should not be considered as quotes or endorsements of a particular insurance product.

All modeled options include adjustments for Required Minimum Distribution (RMD) provisions in the Internal Revenue Code. Those provisions require 401(k) and other qualified tax-deferred account holders who are age 70 ½ or older to withdraw a minimum level of distributions each year. To the extent that distributions generated by the income options illustrated in this interactive model are insufficient to meet the minimum amounts, the distribution is increased to the projected regulatory minimums. This model assumes that the account owner turns 70 ½ and takes the first required distribution in the same calendar year that the owner turns 70. The withdrawal option that is based on the RMD methodology (i.e., "RMD-based" withdrawal method) uses life expectancy factors found in IRS Publication 590-B for withdrawals prior to the starting date for RMDs.

About this report: This retirement model is a part of 401(K) PLANS: DOL Could Take Steps to Improve Retirement Income Options for Plan Participants. The full report is available at: http://www.gao.gov/products/GAO-16-433.

About this methodology: GAO reviewed current and historical capital market data, as well as professional forecasts of key economic indicators, in the development of the assumptions used in this interactive retirement model. GAO's actuaries and an external actuary with expertise in annuity pricing were consulted in the development of the model. See Appendix I of GAO-16-433 for a detailed description of our scope and methodology.

About these data: For the purposes of calculating annuity prices, this interactive retirement income model incorporates data on Treasury yields, corporate bond spreads, and retail annuity prices as of July 2013.