By Andrew S. Zito, AIF® | Executive Vice President, Retirement Plan Services | 08.20.2018
A typical defined contribution plan has a menu of investment options that’s sufficient to help participants accumulate savings over the course of their working lives. But options for generating post-work income tend to be leaner.
Typically, when a plan participant retires, they take distributions from their retirement savings as needed until it is depleted. What happens if these distributions totally deplete an account balance early in the participant’s retirement? Or if a market downturn takes a bite out of the total amount a participant has saved?
The concern over this has led to a new breed of investments called lifetime income options.
Lifetime income options essentially offer an annuity to retiring participants, so their payments are guaranteed, predictable and typically set to extend throughout a participant’s life (and often that of his or her surviving spouse as well). Like any annuity, the cost of the guarantee is offset in the form of a lower payment. In its most simple form, here’s an example of how this works:
Let’s say a participant has $100,000 in their savings at retirement. They could take annual distributions of that of $7,500 per year. That would last them roughly 13 – 15 years. If they opted into a lifetime income option, they would get a payment of (for example) $6,000 per year – but it would be guaranteed to last until they passed away. So even if they lived 25 more years, they would still receive $6,000 per year, for a total distribution of $150,000.
There are several major stumbling blocks for these types of products. The first is employer hesitancy. Employers understandably get nervous any time the words guaranteed, lifetime, and income are used in the same sentence. According to a 2016 survey by Willis Towers Watson, 81% of plan sponsors see fiduciary risk as either a very or extremely important barrier to offering lifetime income solutions.
Another headwind for these products is cost and portability. There is no such thing as a free lunch, and all of these options come with a fee. Given that the products are new, the cost is substantial, which can be a deterrent. In addition, these options tend to be proprietary to the platform that the employer’s plan is on. What happens if the employer moves the plan? Or if the employee terminates employment with the employer? Does the guarantee stop? Is it portable?
Many of the products are working through these hurdles and they are getting help from the government. Longevity risk, or the prospect of running out of money in retirement, is a problem that a handful of legislative attempts have attempted to solve over the past decade. Recently there have been new calls to change the law in order to provide plan sponsors with the latitude to offer annuity options and show participants lifetime income estimates without fear of betraying their fiduciary responsibilities.
The Retirement Enhancement and Savings Act of 2018, a Senate bill with bipartisan support, contains provisions that would standardize sponsor rules on satisfying their prudent-research responsibilities for gaining assurance on the solvency of annuity providers. It’s also intended to create flexibility for participants; if a plan stops offering them as an option it would enable the annuity to be taken from the plan to an outside account belonging to the participant without generating onerous fees.
The Lifetime Income Disclosure Act, a House bill, focuses exclusively on lifetime income projections. This was a high priority for the Department of Labor (DOL) during the Obama administration, but it never came to fruition. This doesn’t focus on creating an annuity stream, but more just illustrating on the participant’s statement, how much income their balance is likely to generate in retirement.
The legal groundwork is already in place for the increased adoption of lifetime income options, and proposed legislation could create even more hospitable conditions for sponsors to act. In the meantime, sponsors can consider directing participants to out-of-plan annuity providers, and it’s worth taking the initiative to ensure participants are educated on how to calculate income estimates and compare their existing options.
For more information contact our team.