Decumulation moves to forefront

Every aspect of defined contribution plans has remained open to debate and tweaks, but increasingly the goal of turning DC savings into an adequate income stream for retirees is the elephant in the room.

For plan design, the transition from accumulation to decumulation “is the next key policy question,” said Jonathan Lipkin, director of public policy at the Investment Management Association, London.

While plan sponsors and regulators have made progress in harnessing consumer inertia in the accumulation phase via auto-enrollment and default options, solutions to ensure people can tackle the more complex decisions on marshalling their savings in retirement remain less thought-out, he said.

With demographic trends poised to further weigh down retirement systems around the world, industry veterans say addressing that gap is a matter of urgency.

A livable income stream should be the goal, rather than getting an impressive-looking lump sum upon retirement, said Don Ezra, co-chairman, global consulting at Russell Investments, New York. In a properly constructed system, a participant should earn more in investment returns on his accumulated DC savings after retirement than he did in the 30 to 40 years leading up to retirement, he added.

Increasingly, the DC conversation is coming around to that topic.

Australia's A$1.5 trillion (US$1.5 trillion) superannuation system has been more focused on which fund got the best returns last month than the question of long-term returns. But “we're beginning to make that transition,” said Alex Dunnin, head of research with superannuation and financial industry research firm Rainmaker Group, Sydney.

A quick pivot on that issue could potentially benefit DC participants around the world that receive lump-sum payouts upon retirement, leaving them at risk of outliving their savings.

For example, Charles Lin, a Hong Kong-based managing director with Vanguard Group and the firm's head of institutional sales in Asia, said it's still early days for Hong Kong's relatively new mandatory DC plan, launched in 2000, but there's evidence that retirees in Hong Kong have been running through their savings within seven years of retirement.

Funneling defined contribution savings into annuities that can provide an income stream for plan members until the day they die is one solution worth exploring.

However, in those countries with compulsory annuities — such as Switzerland — or strict regulations that tend to favor the purchase of annuities, including the U.K. and Chile, annuities have not necessarily provided a secure stream of retirement income either, sources said.

In the U.K., for example, the combination of longer life expectancy and low yields on government bonds that are used to back the annuities have had devastating effects. Average annuity rates have fallen about 30% in the past four years alone, pension experts said.

Instead of a full annuity, options should also include an impaired life annuity or inflation-protected annuity, Mr. Lipkin said.

However, some individuals might prefer to postpone buying annuities altogether, particularly if they are “scaling down into retirement rather than moving from full-time employment straight into retirement,” he said.

“How do we make sure people are in a position to make those choices?” Mr. Lipkin added.

The question of annuities cannot be separated from plan design. Experts noted that many DC plans assume participants will stay employed until they retire, and then there's “this absolute cliff over which they fall when they retire,” said Gordon Clark, director of Oxford University's Smith School of Enterprise and the Environment, Oxford, England.

“Firstly, as we saw through the global financial crisis, the likelihood that many might not continuously stay employed until they reach their retirement age is very real. Secondly, instead of thinking about retirement as being this absolute cliff, there could be fractional drawdown rather than 100% drawdown,” Mr. Clark said. “This will be more relevant if annuity rates continue to show no real recovery.”

In the U.K., where compulsory annuities existed until 2011, the market has become one of the largest in the world. In comparison, only a tiny fraction of DC participants convert their retirement lump sum into an annuity in Australia, sources said. “Sounds like when given choice, people don't like annuities,” according to Nigel Aston, London-based managing director and head of U.K. defined contribution at State Street Global Advisors.

A growing number of governments might decide to make that choice on behalf of their citizens.

Beginning this year, Singapore added a mandatory annuity requirement to its multifaceted Central Provident Fund defined contribution system, after an attempt to introduce a voluntary annuity option in 2007 failed to elicit strong demand from either CPF participants or private financial providers of annuities.

While pointing to annuities as a major piece of the DC decumulation puzzle, Michael Dommermuth, Hong Kong-based president and head of Asia with Manulife Asset Management, said there are near-term obstacles to relying on them in Asia.

Even if considerable cultural resistance can be overcome, bond markets in Asia generally don't have the liquid long-duration instruments of 30 years or more needed to offset the risks private financial firms would be taking on in offering annuities, he said.

The Singapore government addressed that problem by underwriting the annuities itself for the country's CPF LIFE program. At present, a Singapore employee turning 55 in 2013 has to invest just less than S$140,000 (US$113,056) in a CPF Life annuity, and in turn will garner roughly S$1,000 a month in return for life. n