What if Free Choices Lead to Bad Choices?

Presidential candidates John McCain and Barack Obama have proposed to let cash-strapped Americans forgo penalties for early withdrawals from their 401(k)'s and IRAs. For older participants, they've also proposed a temporary relaxation of the requirement that people must make annual withdrawals from their IRAs and 401(k)'s beginning at the age of 70½.

These are not break-the-budget proposals, but, hey, the budget's already broken, so that's not even much of an issue these days. No, the issue here boils down to whether giving individuals the right to make their own financial choices leads to good decisions. And if the answer is no, should the government step in?

So, while the financial hardships of market-battered investors evoke sympathy, several leading pension and retirement experts said they were wary of quick policy switches that encouraged hardship reductions of nest eggs, especially at prices that are at least close to the bottom of the market, if not there yet.

AARP has weighed in to urge relaxation of minimum required distributions for those older than 70½. Not only would the provision force many people to sell securities at depressed prices; the amount of this year's MRD is pegged to account balances at the end of 2007, when many retirement portfolios were 40 percent or more higher than today.

Still, some experts argue, it's not clear how much damage the MRD provision would cause this year. Further, making such a change quickly might not even be possible for the complex systems used by funds and plan administrators to track retirement account activities.

"I totally understand where these proposals are coming from," says Alicia Munnell, director of the Center for Retirement Research at Boston College. "The natural instinct is to say, 'Let's make it easier for people to get access to their funds.' But I think these proposals would be very harmful to people."

"In general, we do not think encouraging people to spend their retirement savings prematurely is a good idea [but]...these are extraordinary circumstances," says Ann Combs, who oversees Vanguard's retirement policy, research, and plan consulting activities. She explains that administering such changes this year would be very hard if not impossible for fund administrators to do. Most beneficiaries have already taken mandatory distributions, and many already are set up for predictable monthly payouts. If changes are approved, she says, they would be more practical to implement next year.

Cynthia Egan heads T. Rowe Price Retirement Plan Services, which handles more than 3,300 defined contribution plans with 1.7 million participants. She notes that among those participants, while signs of financial stresses are certainly higher these days, fewer than 4 percent have done anything unusual in terms of hardship withdrawals and loans.

Gail Buckner, financial planning spokesperson for Franklin Templeton Investments, says allowing older investors to forgo mandatory withdrawals would involve modest percentages of their plan holdings. Life expectancy tables used by the IRS specify that at age 70 ½, the minimum required distribution is less than 4 percent of the account balance.

Further, for IRAs and some 401(k)'s, she notes, investors can take in-kind distributions, meaning they can satisfy minimum withdrawal requirements by transferred securities to nonretirement accounts instead of selling them at steep losses. Then, when share prices recover, they can capture that gain in the new account.

Underlying much advice is the perception that individuals do not make wise investment decisions. And while private-market advocates strongly support individual control of defined contribution plans, the Pension Protection Act of 2006 moved in the other direction through mandated "opt out" participation and investment choices.

These provisions have sharply raised participation rates. And they appear to be placing people in more appropriate investment situations, principally through "target date" funds that provide age-appropriate portfolios that automatically adjust to changing age and rebalance to reflect market results.

However, the early-stage benefits of the 2006 changes were just starting to surface when markets began their 40 percent nose dive. With scrutiny of the self-directed retirement investment industry mounting during the market meltdown, these benefits have been largely overlooked to date by many critics.