Wading Into Retirement Income Solutions
Over the past few decades, the shift from pension plans to defined contribution (DC) plans has made workers, instead of employers, responsible for funding retirement. Employees are on the hook to not only save enough, but also to anticipate, prepare for and wisely execute on a myriad of issues — before, during transition and in retirement. As such, employees struggle to secure a solid retirement with a dependable income stream due to:1
- Competing financial obligations that make planning for retirement difficult
- A lack of knowledge or a feeling of being overwhelmed by complex retirement products and investment choices
- An overreliance on Social Security as a major source of retirement income
- Debt or an inability or unwillingness to change lifestyle
- A late start in saving for retirement compounded by longer life spans and increasing healthcare costs
In addition, many employees approach retirement without a fundamental knowledge of the risks they face, including longevity risk, withdrawal rate risk, sequence-of-return risk and cognitive risk, to name a few. Helping employees save enough — and convert their savings into a healthy distribution stream they won’t outlive — is the industry’s most pressing challenge today.
Employees face a stark reality: They may not have enough money to retire, and they don’t know how to make that money last for their lifetime.
THE "TIPPING POINT"
The retirement industry’s focus has been on the accumulation (saving) phase for more than a decade. The Pension Protection Act (PPA) of 2006, enabling automatic enrollment features, increased contribution limits, and a provision for a safe harbor for default investment selections has positively led to increased participation, contribution and deferral rates. The good news is that more and more plan sponsors continue to embrace these advancements, leading to higher percentages of employees saving more toward retirement in a qualified plan.
Now, however, the industry has reached a tipping point in the urgent need to pivot its attention toward the “decumulation” (income) phase: evolving retirement plans to retirement income platforms, comprised of tools, education and products that give participants the ability to convert their savings into a lifetime income stream.
Alarmingly, 2015 marked the second consecutive year in which 401(k) plan distributions were greater than 401(k) plan contributions.2 And, with more than 20% of U. S. residents projected to be age 65 or over by 2030,3 developing lifetime income strategies and solutions to help with the massive transition is paramount.
STAY OR GO?
For many employers, the retirement income discussion is predicated upon whether the plan prefers retired participants to stay in the plan or not. In a recent Cerulli Associates report, half of plan sponsors prefer that retired participants roll assets to an IRA (most prominent in plans with less than $25 million), in comparison with the 37% that would rather have these assets remain in the plan. Across all plan sponsors who preferred that retired participants leave the plan, 46% cited the belief that participants have access to a wider range of investment options outside of the plan, while 44% listed the administrative costs of keeping inactive accounts open as the top two reasons behind their point of view.4
While a majority of plan sponsors prefer that inactive participants leave the plan, sponsors with more than $1 billion — usually early adopters and leaders of industry change — are one of the few segments that are more likely to encourage participants to leave assets in the plan at retirement, believing:5
- Participants have access to better pricing within the plan (61%)
- Participants have access to retirement planning tools through the plan (52%)
- Participants have access to screened investment options chosen by the plan sponsor (31%)
- The plan has retirement income products (29%)
- Keeping assets in the plan helps to maintain scale to offer the lowest possible pricing (23%)
For plans that prefer participants stay in the plan, they most likely have the tools and products in place to support the decision. Plan sponsors adopting retirement income solutions cite several motivations:
- Supporting participant retirement outcomes and transition to retirement
- Workforce management, including attracting top talent and rewarding long-term employees
- Meeting other corporate goals, such as adapting to changes in existing benefit programs and retaining assets in the plan
Plan size tends to dictate plan philosophy: While they may offer lifetime income education, planning tools or systematic withdrawals, slightly less than half of plan sponsors report having a retirement income product option. As expected, this figure is slightly higher in plans with assets greater than $500 million.6
The catch-22 is that many plan sponsors (mostly in the micro- to mid-size range) remain reluctant to offer lifetime-income products to participants, especially in-plan annuities and in-plan guaranteed withdrawal benefits, due to perceived fiduciary risk, cost, and unsatisfactory or untested market options.7 While they recognize the need to help participants convert accumulated DC plan balances to lifetime income, a large majority (82%) are waiting for the market to significantly develop more with greater fiduciary direction.8
Accordingly, U.S. regulatory bodies have made a concerted effort to address fiduciary risk, and thereby support plan sponsors’ adoption of guaranteed retirement income solutions, through various initiatives:9
- In 2014, the Department of the Treasury issued final regulations regarding qualified longevity annuity contracts (QLACs), making them accessible to the DC and individual retirement account (IRA) markets, and separately issued Notice 2014-66, providing clarification pertaining to tax law compliance when offering annuities within target-date fund structures.
- In 2015, the Department of Labor (DOL) issued Field Assistance Bulletin 2015-02 to help clarify for plan fiduciaries how to exercise fiduciary responsibilities in selecting and monitoring annuities in plans.
A WIDE SPECTRUM
Across the industry, the term “lifetime income solutions” covers a wide spectrum of investment and insurance products, each of which offers a slightly different way to address the lifetime income puzzle. In addition, the term covers education and communication efforts, as well as distribution strategies. Adding to the complexity is that the product-based solutions offered by the plan can either be “in-plan” or “out-of-plan.”11
- Participant assets remain in the plan, either as investment assets or, if a guaranteed product, as a group annuity contract held by the plan.
- Retirement income is paid from plan assets to retirees.
Participant assets are transferred from the plan directly to a selected financial institution or institutions, typically an insurance company, mutual fund company or broker firm, that generates guaranteed or non-guaranteed income for the retiree from the transferred amounts.
- The plan sponsor may be involved in identifying these institutions, communicating them to plan participants and facilitating the transfer of assets out of the plan upon retirement.
- Once assets have been transferred, the plan has no ongoing involvement with the retiree with respect to the transferred assets.
- It is not the same as an IRA rollover, where the plan transfers assets to a financial institution identified by the retiree (as such transactions have not been analyzed or facilitated by the plan sponsors).
Annuity benefits, including any guarantee of a death benefit and lifetime income, extend to the claims-paying ability of the issuing insurance company.
Despite a wide range of lifetime income solutions available, the top three currently offered by mid- to large-size plans in the 2016 Willis Towers Watson Lifetime Income Solutions Survey are:
- Partial and/or systematic withdrawals during retirement (73%)
- Lifetime income planning tools (64%)
- Lifetime income education (60%)
Despite only 8% currently offering an in-plan deferred annuity investment option, it’s the top consideration for 2017 (23%).12 This could be a harbinger of greater adoption of annuity solutions in DC plans of all sizes (not just mega plans), as the market evolves.
LIFETIME INCOME-PLANNING TOOLS
With the rise of financial wellness programs, more plan sponsors are expanding their financial wellness services, tools and education campaigns in an effort to build confidence and reduce stress among participants as they make the transition to and through retirement. For many participants, estimating retirement income needs can be a daunting process, as it requires evaluating and projecting multiple factors. In fact, according to a 2017 Employee Benefit Research Institute (EBRI) study, just half of workers say they feel confident that they know how to protect their accumulated retirement savings as they transition to retirement, and only 38% of workers have estimated how much income they would need each month in retirement.13
Enhanced income-planning tools and calculators now include potential Social Security and pension benefits, spousal assets and assets outside of the DC plan. Tailored to each individual, and based on demographic data and individual inputs, user-friendly, online modeling tools or mobile apps can help pre-retirees and retirees determine how much they can spend each year in retirement. Available through recordkeepers and third-party administrators, these tools can help participants identify income gaps, increase savings via increased deferral rates, review investment options and provide an interactive way to track their progress before, in transition and after retirement.
For plan sponsors reviewing their current income-planning tool, or looking to incorporate one into the plan, consider the following:
- Is it intuitively designed with simple, interactive components that make it easy for people to model different scenarios?
- Does it include pre-populated data relative to each individual using the tool whenever and wherever possible?
- Is it in the forefront of the individual’s experience, being easily accessible in both the Web and mobile environments?