Target-date funds coming to market this year with embedded annuity options could mark a key step forward in the industry’s long slog to help 401(k) participants stretch their retirement savings into needed income for life.
Whether those “hybrid” target-date funds prove a gold spinner for money managers remains to be seen, amid uncertainties regarding how quickly — or even whether — demand from plan sponsors and participants will materialize.
Executives at BlackRock — which stole a march on its rivals in April with its announcement that the firm’s LifePath Paycheck strategy had gone live — have come down squarely on the optimistic side of that question.
The product — which gives target-date fund participants the option of using 30% of their 401(k) pools in the final decade or so of their work lives to secure an annuity-backed paycheck for life — is “going to change retirement” and become a major driver of BlackRock’s growth within three to five years, predicted Larry Fink, the firm’s chairman and CEO, on an April earnings call.
That milestone turned what had largely been theoretical discussions with plan sponsors on retirement income into practical ones, focused on evaluating products and potential implementation, said David O’Meara, New York-based senior director and head of defined contribution investment with consulting giant Willis Towers Watson.
Competing products, with similar features, are set to go live in coming months.
In August, for example, J.P. Morgan Asset Management announced its SmartRetirement Lifetime Income strategy, which begins directing participants’ contributions to a conservative stable value sleeve 10 years out from retirement. As those assets build to 25% of their 401(k) totals, participants can use them to purchase an annuity, if they so opt.
“We’re actively working with record keepers and plan sponsors in determining how we roll that out,” with potential clients showing considerable interest, said Dan Oldroyd, managing director and head of target-date strategies at JPMAM.
The Managed Lifetime Income strategy T. Rowe Price announced in mid-October, meanwhile, is structured around an immediate purchase of a 15-year deferred annuity, using 20% or so of a participant’s savings. The prospect of guaranteed future payouts allows participants to make bigger drawdowns in the interim from the remaining 80% of their 401(k) savings.
“When you defer the annuity 15 years, it becomes much cheaper,” noted Andrew Jacobs van Merlen, co-portfolio manager for target-date strategies in T. Rowe’s multiasset division. “You pay yourself for 15 years and then the insurance company picks up the checks” for the remainder of a participant’s life.
More progress needed
Still, many gatekeepers warn, strategies coming to market this year should be seen as a way station on the path to solving for decumulation, not a destination.
Further progress will be needed on a number of fronts — including better fitting decumulation strategies to participants’ individual needs and preferences — to allow the strategies coming out now to aspire to the kind of ubiquity target-date funds have enjoyed as accumulation vehicles, some contended.
After decades talking about retirement income “with almost no traction,” Kerry Bandow, Russell Investments’ head of defined contribution solutions, said he welcomed the fact that more committees now are talking and thinking about products such as LifePath Paycheck, “which we think very highly of.”
But if that strategy is “as good, if not better than other products … in the marketplace today … it’s not perfect,” Bandow said. To move toward perfection, a higher level of personalization is needed to ensure those products serve the specific needs and preferences of each participant, he said.
“There’s not a one-size-fits-all solution that’s going to meet the needs of most people, the way that target-date funds do today for savers,” agreed Willis Towers Watson’s O’Meara.
Offering a potential source of guaranteed income is a great starting point but it’s not a full plan, O’Meara said. Even with 25% to 30% of savings being channeled into guaranteed income, participants will still have to figure out a safe distribution from the remaining 70% or so, as well as how they should plan for major purchases or set money aside for a bequest.
Keeping it simple
But the level of engagement that personalization will demand from participants could prove a major obstacle to widespread use of hybrid target-date plans, analysts said.
Those new products will only be effective if they’re easy to understand and use — the same conditions that allowed target-date funds to become the dominant vehicle for accumulation, said Victor Lee, a senior consultant and managing director with Verus.
With that challenge in mind, BlackRock’s LifePath Paycheck team sought to keep their product as simple as possible, having found that "if we provide too much choice," too often people will choose to do nothing, said Nick Nefouse, managing director and global head of LifePath at BlackRock.
So instead of asking participants to figure out whether they’d prefer to deploy 10% or 50% of their 401(k) savings in securing guaranteed income, BlackRock settled on 30% as a good baseline that — in tandem with Social Security income — should cover most people’s essential retirement spending needs, he said.
T. Rowe’s Van Merlen, while agreeing that complexity is a challenge, said his firm remains focused on providing participants with options, to help them make “more personalized choices and ultimately end up with their own kind of income strategy.”
“The idea of offering one product that’s going to be a blockbuster in the retirement income area is probably a little bit misguided,” he said, noting that better outcomes are likely “if we can give our investors choices.”
A challenge to IRAs?
That tension between simplicity and personalization points to a looming tug of war between 401(k) plans and financial planners if products such as LifePath Paycheck prompt participants — who typically roll defined contribution assets over into an individual retirement account when they retire — to stay in plan longer.
That’s a trend enjoying a regulatory tailwind now, noted Kevin Crain, executive director of the Institutional Retirement Income Council, a nonprofit think tank for the retirement income planning community. The government in recent years began showing a lot more interest in encouraging plans to let participants stay in long term, concerned that too many rolling their defined contribution savings into IRAs were ill-informed and ending up in high-cost solutions.
That, in turn, spurred innovation by money managers eager to make target-date funds fit for purpose for decumulation as well as accumulation, Crain said.
JPMAM’s research shows 85% of participants saying that “they would stay in their plan after retiring if there was an in-plan retirement income option offered,” said Steve Rubino, JPMAM’s head of retirement.
But to compete with financial planners, WTW's O’Meara said, managers offering hybrid plans now must move beyond that starting point to make their decumulation strategies “really fit for purpose … getting us into the estate planning end of the question.”
Not for everyone
Of course, the hybrid plans coming to market now will only prove of use to participants who’ve managed to accumulate a meaningful amount of 401(k) savings.
A participant who retires with $1 million in 401(k) savings and uses $200,000 of that total to purchase a 15-year deferred annuity could expect about $5,000 a month when those payouts begin, or around $60,000 a year, noted T. Rowe's Van Merlon.
But the average 65-year old in the U.S. today probably has closer to $75,000 in 401(k) savings, which would provide for a $750 monthly check for the rest of their lives, he said, adding “that’s not a solution."
And that, in turn, points to the need to be able to look at a participant’s full financial picture — from real estate holdings to outstanding 401(k) pools left stranded as participants changed jobs over a career — in determining how much can be spent on securing a guaranteed income stream.
For now, predictions of how quickly demand for hybrid funds could take off vary sharply — with some anticipating widespread adoption and others saying this year’s crop of new strategies could quickly become yesterday’s news.
“I don’t know the direction of travel from here — how fast we’re going to go,” said WTW’s O’Meara. Even if demand accelerates from here after a long period of very slow growth, “they might never be mainstream,” he said.
Nefouse said roughly half of the 15 plan sponsors with combined retirement assets of $27 billion BlackRock announced in April as initial LifePath Paycheck clients are in and the other half will go live over the coming year, he said.
Bill Ryan, a partner and head of defined contribution solutions with Boston-based investment consultant NEPC, said he remains skeptical, predicting that no more than 10% of participants will likely be in the market to buy an annuity.
"There's a higher probability, if they engage at retirement, they take all the money out, move it to their own personal wealth adviser, who then may facilitate something similar," Ryan said. In the defined contribution construct, "we're missing the human wealth manager that actually helps the individual trigger the annuity. There's nobody holding the hand of the participants to successfully facilitate that transaction ... and that human behavior is where I think this breaks down."
Instead, Ryan predicted, passive target-date funds with elevated equity exposures could prove to be the “killer app” in the retirement space, allowing participants to build up bigger 401(k) retirement pools over a working life of 40 years or more which they can then rely on for a “paycheck” in retirement, without the need of a guaranteed income crutch.
Participants who have undersaved, meanwhile, could be worsening their situations by paying an insurer a premium to get a guaranteed income stream. “They actually could put themselves in a bigger deficit,” he said.
