Retirement Income is an Evolutionary Process

Many defined contribution (DC) plan sponsors are expanding their focus on the retirement needs of their plan participants in the decumulation phase and are realizing that there is no one-size-fits-all solution – whether for their retirees or for the DC market as a whole. As plan sponsors explore the many alternatives, they should consider taking a series of steps towards improving retirement outcomes for their plan participants, rather than focusing on just one solution, said Josh Cohen, Managing Director and Head of Institutional DC for the Institutional Relationship Group at PGIM, the asset management business of Prudential Financial. “Retirement income in DC plans will be evolutionary, not revolutionary,” he added.

While many plan sponsors are saying they are interested in lifetime income solutions, they also note that it’s a complicated area with many hurdles. “The lesson is there isn't a magic bullet product that you can just select that’ll allow you to say, ‘I'm solving for lifetime income,’” Cohen said.

Cohen sees customization as increasingly important in finding the right solutions for lifetime income. A recent PGIM paper, ‘Spending and Retirement,’ showed each participant profile has different spending needs, both non-discretionary needs like housing as well as discretionary income or wants like vacations or bequests that can be managed more with diversified portfolios. Individuals have different needs and wants. And they have different sources of both predictable income, like defined benefit and social security, and also non-predictable income, such as what’s in their DC plan, Cohen noted.

“As we evolve retirement plans, lifetime income solutions will need to address the risks that maybe traditional plans haven't done thus far. We need to think about unique market risks in retirement, including inflation risk. Interest rate risk is another risk that is underappreciated when it comes to lifetime income. Now that we're in such a low-yield environment, it's more and more expensive to secure income. And then, of course, there's longevity risk, which is why something like annuities are needed,” he said.

Plan sponsors can take several steps, from plan design to communications to adding investment products and strategies, to support lifetime income, noted Cohen, speaking at Pensions & Investments’ Retirement Income Virtual Series, on the session ‘Innovations Being Developed to Meet the Income Needs of Long-Living Retirees.’ One instance is the SECURE Act’s directive for the Department of Labor to provide a framework requiring plan sponsors to provide projected lifetime income on participants’ statements. Different plans have different needs and will have a different pace in moving forward on retirement income, he said.

“Next-generation solutions will need to combine different products and solutions to solve for lifetime income. This won't be solved with a single product that you can throw on the menu and that participants will just elect to go into,” said Cohen, adding that it will be challenging as there are different products from different providers. “We need to combine asset allocation, technology, and institutional investments, both non-guaranteed investments to support systematic withdrawals as well as guaranteed investments,” he said. “This isn’t easy for plan sponsors to do, let alone participants on their own, and so the process needs to be wrapped in professional management and it should include a quality participant experience.”

“As plan sponsors need to really think about retirement outcomes and to solve what is—as Bill Sharpe is famously quoted as saying—‘one of the nastiest, hardest problems in finance,’ retirement income is, as they say, going to take a village,” said Cohen. It will take investments, both guaranteed and non-guaranteed solutions; it will take technology; it will take engagement with participants through advice, seminars, and websites, he said. “That’s hard to do as we do tend to be in a product-centric world. But to crack this nut, we have to look at how we bring all of these together to truly solve for lifetime income.”

Cohen sees target-date funds as probably the best innovation that the retirement industry has seen, certainly from an investment perspective. While it is natural that TDFs became the go-to QDIA, particularly after the Pension Protection Act, he also credits the DOL with foresight, over a decade ago, in identifying managed accounts as a potential QDIA. Looking ahead, target-date funds need to preserve their professional management, their default nature, and their design to decrease risk over time, which are all helpful for do-it-for-me investors who are, in fact, most participants, Cohen said, adding, “For target-date funds to solve for lifetime income, customization will become increasingly important.”

The ‘Spending and Retirement’ study on different income cohorts showed those that earn $40,000 to $50,000 a year tend to need an 83% replacement ratio, whereas those that earn $100,000 to $110,000 a year need a 60% replacement ratio, Cohen said. The lower-paid cohort tends to have a higher amount of non-discretionary needs or income, relative to discretionary income. “That really means that investment solutions need to start to be different for those folks. And for target-date funds to truly solve some of the unique risks in retirement, such as interest rate risk and longevity risk, they need to evolve and to incorporate more liability-driven types of investments,” he added. He sees interest in products like dynamic QDIAs, which make a strong case for the first 20 years or so of the participant’s savings journey, he said. “But as you get closer to and into retirement, that’s where we need even more customized solutions over time.”

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