From Cradle to Grave: How to Loot a 401(k) Plan

The regulations governing asset distributions from many retirement plans give plan participants the option to time retirement or rollovers from the plan strategically. They possess a long-lived put option, whose exercise price resets periodically to the current value of the assets in the plan. We derive a recursive closed-form valuation formula for the option, and develop a numerical algorithm for implementing the result. We find that, for reasonable assumptions about volatility and life expectancy, the option’s value may approach 40% of the value of the assets in the plan, financed entirely by those still contributing. This wealth transfer can, however, be easily avoided by making a simple change to the current regulations governing valuation and payout of these retirement plans. JEL classification: G12, G13, G23. ∗I thank Jonathan Berk, Richard Lyons, Mark Rubinstein and the referee for helpful comments and suggestions, Sam Thompson and Joel Vanden for expert research assistance, and Nicky King and the administrators of the Sola Optical 401(k) plan for first making me aware of the subject of this article. I gratefully acknowledge financial assistance from the Berkeley Program in Finance, from the U.C. Berkeley Committee on Research, and from the Fisher Center for Real Estate and Urban Economics.