Retirement tiers emerge from hiding in DC plans

Updated with correction: Roughly 7% of plan sponsors offer a retirement tier and 9% are considering implementing one, according to a Cerulli survey.

In December 2020, as the world grappled with the pandemic, the ABA Retirement Funds program — a retirement plan used by some 4,100 law firms and organizations connected with the practice of law — rolled out an investment tier designed specifically for retirees and those nearing retirement.

The new retirement tier was made up of four retiree-focused funds that Scarlett Ungurean, the Chicago-based executive director at ABA Retirement Funds, described as "objective-based."

The tier included a capital-preservation fund, an inflation-protection fund and a diversified growth fund, which Ms. Ungurean said were "clones" of what was available in the core investment menu, as well as an income-focused fund, which was new.

Adding the tier to the $5.5 billion plan would encourage participants to keep their assets in the plan upon retirement and give them a much better deal on fees than if they were to move their money into an individual retirement account, Ms. Ungurean said.

"We thought we'd be taking care of our participants," she said, explaining that more than 1 in 3 participants are over age 50.

The new tier was marketed to the over-50 set as part of a "retiree toolkit," which included a Social Security optimization tool and a retirement planning guide. The tier does not yet offer annuities or other guaranteed income investments.

"That's retiree menu 2.0," Ms. Ungurean said, referring to the future possible addition of annuities.

Ms. Ungurean declined to disclose how much was in the tier, saying only that assets grew 25% from 2021 to 2022 with the number of participants jumping 72% during that time period.

The ABA Retirement Funds is among the relatively few plan sponsors that offer and market a retirement tier to plan participants over 50 but experts say that more plan sponsors are expected to make similar tiers available as baby boomers continue to retire in massive waves and increasingly rely on their workplace retirement plans as their primary source of retirement income.

While plan sponsors have been slow to adopt retirement tiers to date, they are asking more questions about them and what would fit their participant population, said Jonathan Lakin, principal and senior investment consultant at Mercer LLC in Dallas.

That could be systematic withdrawal options, financial planning from record keepers, or retiree-focused investment options within the plan, he said.

Gregory Fox, partner and head of the DC retirement income solutions group at Aon Investments USA Inc., in Monroe, Conn., also reports that more plan sponsors are asking questions about retirement tiers, with some implementation starting in 2020 and then "picking up quite a bit in 2021 and 2022," he said.

Roughly 7% of plan sponsors offer a retirement tier and 9% are considering implementing one, according to a survey of 23 top DC consulting firms conducted by Cerulli Associates in the second and third quarter of 2022.

Cerulli defined a retirement tier as a range of products, tools and services that allow a plan sponsor to broaden the plan's goal "from one wholly focused on saving to one that can transition to support benefit distribution for participants who are near, entering or in retirement," the survey said.

The majority of plan sponsors with a retirement tier are starting out with a basic tier that includes objective-based investments such as those offered in the ABA Retirement Funds program, Aon's Mr. Fox said.

The ABA program is "probably more reflective than not of most employers out there sort of easing into it by exploring non-guaranteed solutions first," he said, adding that such starter tiers are sometimes coupled with out-of-plan annuities either at the same time or shortly thereafter.

While most plan sponsors "ease into" a retirement tier without including annuities, some are more aggressive, wishing to offer a tier with the "biggest impact" it can, Mr. Fox said.

"Some employers are bypassing the ease-in process and going straight to a more disruptive way of incorporating these solutions into their menu and into a retirement tier," he said.

In addition to retiree-focused investments, such as capital preservation and inflation-protection funds, retirement tiers can include anything from managed payout funds to both in-plan and out-of-plan annuities.

Almost all plan sponsors, in fact, have a retirement tier but don't realize it or don't label or market it that way, several consultants said. The key investments in a retirement tier include funds that are typically found in a plan sponsor's core investment menu, as is the case with the ABA Retirement Funds program.

Three of the four investments in the ABA plan – the capital preservation fund, the inflation-protection fund and the diversified growth fund – are all in the core investment menu under different names. Only the income-focused fund is offered exclusively in the retirement tier.

The majority of plan sponsors already offer retiree-focused investments but haven't spent the time to package and market them as a retirement tier, said Bill Ryan, a partner and head of defined contribution solutions at NEPC LLC in Chicago.

Plan sponsors haven't gone the extra step of saying, "Of the 10 options we provide, these three are the best to use for short-term needs in retirement to draw down," he said. "The majority are not marketing it, even though they have the parts."

Mr. Ryan cited NEPC client data showing that 76% of plan sponsors offer stable value funds, 43% offer money market funds, and almost a third offer inflation-protection funds, three of the essential building blocks in a retirement tier.

Greg Ungerman, a senior vice president and defined contribution practice leader at Callan LLC in San Francisco, agreed, saying that retirement tiers are available in investment menus but not marketed as such to participants.

"When we use this tiered concept, it tends to be a construct that you use when communicating at the plan sponsor level as opposed to the participant level," Mr. Ungerman said.

In addition to stable value and inflation-protection funds, these tiers also include core-plus funds, which are traditional fixed-income funds, Mr. Ungerman said.

For some consultants, the traditional target-date fund, which is pervasive in plans, is the ultimate retirement tier, even though it isn't marketed as such.

"We believe that the No. 1 retirement income solution is a target-date fund plus systematic distribution as the first line of defense," Mr. Ryan said.

While the target-date fund feels like a "vanilla concept," it is "probably the best option in retirement because some professional has built a portfolio that's targeting a 4%, 5% or 6% rate of return in retirement," he said. "If an individual is taking out 4% or 5%, it matches the dividend that they need to draw for an income without depleting the balance in retirement."

For Mr. Ryan, the target-date fund is akin to Batman. "It's the hero we need; maybe not the hero we want," he said.