Lifetime Income Solutions Should Solve for Longevity Risk

Defined contribution plans have made steady strides over the last decade in helping their participants navigate the difficult saving and investing decisions they face throughout their working lives. Today’s DC plan sponsors have expanded their focus on the full trajectory of the participant’s retirement journey, from accumulation through decumulation, to help maximize retirement outcomes for their employees. However, addressing this decumulation aspect involves navigating a complex set of challenges to select the retirement income solutions that would be most appropriate for their employee base.

“Lifetime income as a concept is neither new nor revolutionary, but retirement income products like annuities, drawdown products, or customized advice solutions present a number of challenges and trade-offs for plan sponsors to consider,” said Brian Murtagh, Vice President and DC Investment Strategist, at State Street Global Advisors. “Concerns around complexity, fiduciary obligations, costs, and portability have all presented hurdles to broad-based plan adoption of lifetime income today.”

Murtagh pointed to the crux of the challenge that faces plan sponsors today as DC plans move closer to being the primary or only savings vehicle for employees. “As we've shifted from the DB framework to a DC framework, the onus is now on the individual to not only manage the accumulation aspect, but also the decumulation aspect,” he said.

Participant research by State Street¹, which manages over half a trillion dollars in DC assets globally, showed 85% of active U.S workers say they are most responsible for ensuring they have sufficient retirement income, rather than another entity such as their employer or the U.S. government. “However, we know that there's a lot of uncertainty around longevity risk. Not knowing if you're able to live to age 75, 85, or even 95 or older means that you, as an individual, have difficulty in planning how to draw down your assets in retirement,” said Murtagh, at a Pensions & Investments’ Retirement Income Virtual Session on ‘Innovations being Developed to meet the Income Needs of Longer-living Retirees’. The same research also showed that 75% of American workers say they would value a retirement income solution provided by their employer.

“As plan sponsors consider retirement income solutions, there are a number of tradeoffs to weigh,” Murtagh said. The first is liquidity. “Broadly speaking, plan sponsors seeking an income solution can choose between annuity and non-annuity products. Non-annuity products generally remain liquid and may try to steer participants in the right direction by offering something like a personalized decumulation recommendation or a default drawdown framework, but they don't necessarily address that risk that participants will outlive their savings. On the other hand, annuities can protect against that longevity risk, but they are typically illiquid and irrevocable. Unsurprisingly, the participants that we surveyed are looking for a combination of both flexibility and security in their retirement income, so it's really important to consider this tradeoff,” he said.

Secondly, related to the conversation on liquidity is the question of portability. “At the plan sponsor level, consider whether selecting a particular income solution will limit your ability to change record-keepers in the future. At the participant level, consider all the options that would be available to those participants who change employers and the potential costs of those decisions. An annuity contract is typically tied to the plan sponsor and it could be costly and challenging for that participant to unwind. Some products do offer more portability and could allow participants to roll over that balance into an IRA version of the product as well,” Murtagh said.

While there isn’t going to be a one-size-fits-all retirement income solution for the market, addressing longevity risk is a driving concern for many of State Street’s defined contribution clients, added Murtagh “If we agree that longevity risk is what we're trying to solve, then deferred income annuities can be an efficient tool for addressing that challenge. Participants can use a portion of their balance at retirement to buy that deferred annuity that kicks in when it’s needed for that late-life drawdown stage,” he explained. State Street’s retirement income solution, IncomeWise, builds on the success of today’s target date funds, which are typically the default option for DC plans, by giving participants the option to purchase a deferred income annuity (known as a Qualified Longevity Annuity Contract or QLAC) in order to help DC participants protect against outliving their savings, he said.

As plan sponsors weigh the array of innovative retirement income solutions available, they should think about participant behavior as well. In the accumulation phase, participants have a range of options from target date funds or the core lineup to a brokerage window, but a majority don’t engage actively in their DC plan, Murtagh noted, adding they typically go into the default option with auto-enrollment and, hopefully , auto-escalation as well. “Similarly, we think that having the deferred income annuity as part of the default solution improves upon the existing target date framework by giving participants an option to more explicitly address that longevity risk and provide more efficient drawdowns in retirement,” he said.

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Footnotes 1. 2018 Global Retirement Reality Report, State Street Global Advisors

Disclosures:
For Institutional / Professional Investors Use Only
A qualified longevity annuity contract (QLAC), is a type of deferred income annuity which is an insurance product that guarantees money at a future date, typically for the rest of an individual’s life. Payment of lifetime income through a QLAC is subject to the claims-paying ability of the issuing insurance company; it is possible that the issuing company may not be able to honor the income payouts at any time. Participants who redeem from IncomeWise prior to the QLAC purchase will not be eligible for the QLAC benefits. The QLAC is subject to regulatory limitations. The QLAC purchase is subject to market availability and cannot be guaranteed in any given year. The QLAC is not provided by or guaranteed by SSGA or any affiliate of SSGA. Neither IncomeWise nor the QLAC are insured by the FDIC or by another governmental agency; they are not obligations of the FDIC or deposits or obligations guaranteed by SSGA. You cannot reverse the purchase of the QLAC

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