Quick Summary
Many 401(k) plans are designed around saving and offer retirees little more than a lump-sum payout. Plans can add flexible withdrawal features, such as partial withdrawals and installment payments, that let retirees draw income while staying in the plan. Some plans also offer annuity options, which bring their own trade-offs in cost, complexity, and portability. The SECURE Act added a safe harbor for selecting annuity providers and lifetime income illustrations on statements, but each decision still requires a prudent, documented fiduciary process.
For most of a career, a 401(k) has one job: help employees save. The plan handles enrollment, contributions, investments, and statements. Then an employee retires and the question changes from "how much should I save?" to "how do I turn this into a paycheck?"
Many plans are not built for that second question. Some offer little more than a lump-sum payout, which pushes retirees to roll their money out or, in some cases, cash it out entirely. Plan sponsors have more options than they might realize, and the right mix depends on the workforce and the plan.
The gap at retirement
Retirees face decisions that are different from saving. How much can they withdraw each year? How long does the money need to last? How do withdrawals interact with Social Security, taxes, and required minimum distributions?
Congress has nudged plans to address income more directly. Under the SECURE Act of 2019, participant benefit statements must show, at least once a year, an illustration of the account balance converted into estimated monthly lifetime income. Those illustrations are estimates, not promises, but they help employees think about their savings as future income rather than just a balance.
Flexible withdrawal features
The simplest income tools involve no new investment at all. They are distribution features written into the plan document:
- Partial withdrawals. Retirees can take money out as needed instead of withdrawing everything at once.
- Installment payments. Retirees can set up regular monthly, quarterly, or annual payments from their account.
- Required minimum distribution services. The recordkeeper calculates and pays RMDs automatically.
These features let retirees keep their savings in the plan, with its investment oversight and institutional pricing, while still drawing income. Some small plans do not allow partial withdrawals after separation from service, which leaves retirees with an all-or-nothing choice. Adding these features usually requires a plan amendment and confirmation that your recordkeeper supports them. With many plans updating their documents for SECURE 2.0, it can be a good time to review distribution options as well.
Annuity options
Some plans go further and offer access to annuities, which convert savings into income for life backed by an insurance company. There are a few common designs:
- Annuity purchase at distribution. The plan offers a way for retirees to buy an annuity with some or all of their balance when they leave.
- In-plan lifetime income investments. Some products, including certain target date designs, build an income feature into an investment that participants hold before retirement.
- Qualifying longevity annuity contracts. These deferred annuities begin payments later in life and receive special treatment under the required minimum distribution rules.
Annuities can address the risk of outliving savings, which is hard to manage with withdrawals alone. They also come with trade-offs: fees that can be higher and harder to compare than fund expenses, contract terms that can be complex, reduced flexibility once money is committed, and reliance on the insurer's financial strength and claims-paying ability.
The SECURE Act created a safe harbor for fiduciaries selecting an annuity provider. Fiduciaries who follow its steps, which include obtaining written representations about the insurer's licensing and financial condition, have a clearer path to showing they acted prudently. The safe harbor addresses the choice of insurer. Fiduciaries still need to consider whether the product's costs are reasonable for the benefits it provides.
The SECURE Act also addressed portability. If a plan removes a lifetime income investment, for example after a recordkeeper change, the plan can generally allow participants to move that investment to an IRA or another plan so they do not lose the features they paid for. How that works in practice depends on the product.
Not every plan needs an annuity option. For many small plans, flexible withdrawals and good education address most of what retirees need.
Keeping retirees in the plan: pros and cons
Making a plan more retiree-friendly has advantages. Retirees keep access to the plan's investments and pricing, and they avoid sales pressure from products that may not serve them well.
There are also considerations for the sponsor. Retiree balances count toward participant totals, which can affect whether the plan needs an annual audit. Fiduciary duties continue for as long as the money is in the plan. And the plan needs current contact information for people who no longer work for you. These are manageable issues, but they belong in the decision.
Education and advice
Turning savings into income involves more than plan features. Retirees benefit from help with withdrawal rates, Social Security timing, taxes, Medicare, and coordinating multiple accounts. Pre-retirement education sessions, one-on-one meetings, and access to a financial planner can help employees make decisions they are comfortable with.
Questions to ask about your plan
- Does the plan allow partial withdrawals and installment payments after retirement?
- Does the recordkeeper offer automated RMD processing?
- How many participants leave the plan at retirement, and why?
- Has the committee discussed lifetime income options, and is that discussion documented?
- What retirement planning education do employees receive in the years before they retire?
Want to make your plan work better for employees approaching retirement? Brian Williams, CPFA®, of Northshire Consulting LLC | Registered Investment Advisory Firm helps business owners review plan design and participant education. Call 203-401-6062, email bwilliams@northshireconsulting.com, or visit northshireconsulting.com to schedule a plan review.
Frequently asked questions
Are we required to offer an annuity in our 401(k)?
No. Annuity options are voluntary. Many plans focus on flexible withdrawal features and education instead, and the decision should reflect your workforce and a documented fiduciary review.
What happens to an in-plan annuity if we change recordkeepers?
The SECURE Act allows plans to let participants move a lifetime income investment to an IRA or another plan if the investment is removed from the plan. The specifics depend on the product and the providers involved.
Can retired employees keep their money in our plan?
Generally, yes. Retirees can usually leave their savings in the plan and take required minimum distributions once those apply. The plan document may allow small balances to be distributed without consent, and some plans limit how retirees can take withdrawals, so check your document.
This material is for educational purposes only and is not individualized investment, tax, or legal advice. Advisory services are offered through Northshire Consulting LLC | Registered Investment Advisory Firm.