TARGETING RETIREMENT SECURITY
Retirement Income Webinar
Defined contribution plan sponsors have successfully helped their participants save for retirement through plan design features, such as automatic enrollment; and escalation and default solutions, such as target-date funds. They’ve now extended their attention to the decumulation phase and are exploring ways to help employees optimize income in retirement. While this is a significantly more complex problem than the savings phase, due to individualized circumstances and needs in retirement, it is seen as a necessity to deliver financial security in retirement.
In-plan retirement income is no longer a hypothetical offering. The DC industry has risen to the challenge by developing, evaluating and implementing innovative solutions, both in plan design and investment offerings. So far, no one solution dominates the retirement income landscape. They range from systematic withdrawals and managed accounts with income planning to target-date funds with managed payouts and guaranteed lifetime income, as well as immediate and deferred annuities.
State of the industry
“The challenge with retirement income is that it means something different to everyone,” said Greg Ungerman, senior vice president and defined contribution practice leader at Callan. “Some think of it as a guarantee, others as a nonguaranteed solution, others as a payout fund. The industry is figuring out what they want to come to market with.”
What is clear is that the retirement income landscape is rapidly progressing. Ungerman pointed to advances by record keepers, in particular, who have often been painted as a bottleneck in implementation of solutions. “They have been reinvesting in their technology as well as in delivering outward-facing, participant-facing solutions. They’ve come a long way, even as they still have a long way to go.”
“Plan sponsors are looking for flexibility and to have the ability to choose from a broad array of offerings to meet the needs of their diverse workforce,” said Nathan Voris, head of channel strategy at Morningstar Investment Management LLC. The firm has seen increased interest in providing retirement income products at the plan sponsor level as well as increased due diligence at the consultant level.
“Guaranteed income has largely gone away in corporate America, and participants are living longer,” said Brendan McCarthy, head of retirement investing at Nuveen. Only 12% of Americans today have access to a defined benefit plan, he noted. At the same time, for a couple aged 65, there is a 46% chance that one spouse will live until age 95 or longer, he pointed out. These contrasting trends explain why the need for lifetime income has never been greater.
Adoption of in-plan retirement income solutions has accelerated throughout 2023, said James Veneruso, vice president and head of DC product strategy, Americas, at State Street Global Advisors. “We’re moving past the conversation on education of plan sponsors. We’re starting to see plan adoption and commitments, which is a departure from the past.”
Beyond implementation issues, DC plan sponsors face additional challenges in assessing the suitability of retirement income for varying employee demographics, and in addressing potential engagement by participants, Callan’s Ungerman said. “Auto features for participant savings allows them to set it and forget it. The older population is much more heterogeneous than the younger generation, and an auto feature might not be appropriate for retirement income.”
Ungerman said the interplay of demographic and financial factors influences Callan’s assessment of different retirement income investment offerings. “We review the manufacturing of products. They are all different. All have pros and cons. They each have different objectives and different trade-offs to consider.”
It is incumbent on plan sponsors to understand the profile of their participants to determine suitability, Ungerman said, which is another area of focus for Callan. For example, “we’ve asked plan sponsors, “What’s the average turnover for your population?” If employees stay for only a few years, maybe a retirement income or guaranteed solution isn’t appropriate.”
Callan also examines whether plan design allows for rolling in balances from previous employers’ DC plans, leading to a more sizeable account balance that can be used to generate retirement income. “We consider a range of factors that helps inform the appropriate retirement income solutions for each plan sponsor,” he said.
Overcoming the disconnect
Despite the need and desire for plan sponsors to offer more retirement income products, Morningstar Investment Management’s Voris noted a disconnect with what is currently available in the marketplace and what is still under development. “There’s an array of offerings, but very few of them are available today that can be implemented in a reasonable time frame. In this environment, the plan sponsor tends to make a decision based upon what’s available at the record keeper.”
Hence the selection of a record keeper or other product provider who can deliver retirement income products is a crucial decision for DC plan sponsors. That capability “will give the plan sponsor flexibility in designing a suite of services that fits their demographics,” Voris said.
Source: Callan Institute, 2023 Defined Contribution Trends Survey
“Currently, the greatest interest is in products delivered to plans via record keepers that have an insurance practice,” said Bryan Platz, vice president, investment and product specialist at Morningstar Investment Management LLC. He further observed that beyond record keeper capabilities, adding retirement income involves plan sponsors making decisions about portability, cost and participant demographics.
Though these factors are important, what is ultimately key to successful adoption is personalization, Platz said. “A successful retirement income offering needs to look at the participant individually. An all-in-one solution could lead to some participants over-allocating to a guaranteed product, reducing potential growth. Other participants could underallocate to a guaranteed product and take on unnecessary longevity risk. Regardless of what product is chosen, it must be flexible enough to incorporate the individual participant’s needs.”
Whether plan sponsors consider a guaranteed or a nonguaranteed income product, the personalized approach delivers the best outcomes, Voris said. “There is an emerging consensus that a managed-spending offering, where the participant can engage and get personalized advice, is going to be critical to the success of retirement income.”
“We are seeing strong demand from participants for in-plan lifetime income offerings. Research shows it could be used to motivate recruitment, retention and allow employees to retire on time,” said McCarthy at Nuveen. “70% of employers, according to the TIAA 2022 Retirement Insights Survey, agree that their DC plan should include lifetime income options.”
Despite the demand and need for lifetime income, adoption has been comparatively slow, McCarthy pointed out. “There is a significant infrastructure and technology build required by most record keepers to offer these third-party annuity solutions.” Yet the technological delays are not impacting plan sponsors’ decision making around retirement income. “Plan sponsors are going through the fiduciary process of assessing the needs of their plan’s participants, conducting the due diligence on the universe of lifetime income options and starting to select the solution that best fits the needs of their plan, regardless of current record-keeper availability.”
2 EBRI Retirement Confidence Study, 2020
Do no harm
Plan sponsor committees have traditionally tended to move cautiously, given the importance of their decisions, observed Veneruso at State Street Global Advisors, but consultants are helping expedite adoption of retirement income solutions.
“Consultants are becoming comfortable with the retirement income landscape. Coordination is also required in terms of the participant experience and record keeper integration,” which is now taking place, he said. As a result of these changes, committees themselves are becoming more familiar with retirement income and are ready to add solutions.
“A range of solutions is appropriate, given that you have a range of participants. There is no one-size-fits-all silver bullet,” Veneruso said. He argued that the diverse needs of participants necessitate diversity of retirement income choices. “Just as there are multiple investment options in the accumulation phase, we will likely see multiple options for the decumulation phase.”
Veneruso said the principal of “do no harm” should underlie plan sponsors’ decisions when it comes to adding retirement income. “Can the plan offer a retirement income solution that doesn’t affect participants who aren’t going to use it? You don’t want to disadvantage or raise fees on people who don’t select the solution. Doing as little harm as possible, relative to the rest of the plan lineup, will be a key criteria for plan sponsors as they consider adding retirement income.”
Diversity of Approaches
There is no silver bullet for retirement income because participants’ needs and circumstances in the spend-down phase vary so widely. DC plan sponsors have an array of solutions on the retirement income menu to consider, though their record keepers’ capability of delivering the solution is a critical consideration. Beyond the selection of an investment solution, plan sponsors are also addressing the deeper issues of plan design and participant engagement.
Integrating the approach
There are two basic ways that plan sponsors decide on a retirement income solution, according to Nuveen’s McCarthy, “a check-the-box approach or an integrated approach.” In the former, “sponsors generally don’t adjust plan design during accumulation and, at the point of retirement, offer participants an option to purchase an institutionally priced annuity.”
By contrast, an integrated approach involves redesigning the plan so that the introduction of options for retirement income occur during the accumulation or pre-retirement phase, McCarthy said. “We are seeing more interest in the integrated approach because it tends to result in higher adoption of an income solution by participants at retirement.”
Nuveen offers an integrated solution to sponsors through its income target-date series. “It offers plan participants guaranteed savings growth during their working years and the ability to set aside a portion of savings for guaranteed monthly payments that will last for life in retirement. It’s done automatically. In fact, the guaranteed income is managed by our parent company TIAA, the only company that’s been delivering lifetime income for over 100 years,” McCarthy said.
“Target-date funds adapted to embed a lifetime income offering are seeing the most interest from plan sponsors,” McCarthy added. “The solution incorporates what is perceived to be a complicated investment into an existing product.” Its key advantage is simplicity and ease of understanding for participants. “Retirement income offerings should be simple for participants and the target-date structures may offer the simplest way for plan sponsors to introduce these solutions to their employees,” he said.
Retirement income solutions bring with them complexities and decisions for sponsors, said State Street Global Advisors’ Veneruso, noting that “one of the biggest is, how do you solve the question of participant engagement?”
Most participants in target-date funds have been defaulted into them and so tend to be the least engaged participant population, he pointed out. This issue becomes critical if plan sponsors decide to default participants into a retirement income solution with potential higher fees or irrevocability. “How are you getting them to make an informed decision?” Veneruso asked. Education is important, but plan design is critical too.
State Street Global Advisors’ retirement income solution, which is embedded in a target-date fund, addresses these issues. “The hallmark of our overall approach is ‘do no harm,’” Veneruso said. “If a participant opts to not elect for retirement income, it’s the same exact target-date experience. There are no fee differences. If they do opt in to retirement income, they would see a period of immediate income in early retirement. This is flexible, stable, nonguaranteed income.” The offering also includes longevity protection, which provides guaranteed income later in retirement, he explained.
“There needs to be a broad range of services and products that solve for the needs of a broad, diverse customer base,” said Morningstar Investment Management’s Voris. Participants vary greatly in their retirement account balances, sources of income in retirement — such as access to a defined benefit plan — preferences for working part time in retirement and expected medical costs, he noted.
Though target-date funds could, in theory, solve for these disparate needs, said Platz at Morningstar Investment Management, “the difficulty is allowing the portfolio manager to determine the appropriate amount of income every participant will receive, regardless of their unique financial situation.” Hence products that offer personalization are the optimal approach for delivering income in retirement.
Morningstar Investment Management’s service, Income Secure, is a managed-account drawdown strategy which utilizes the firm’s asset allocation engine. It is not a one-size-fits-all product — it is highly personalized to each participant. “We look at the underlying demographics of the individual and create a portfolio that is customized to them,” Platz said.
The product guides the participant through decumulation in a tax-efficient way. In the same way that Morningstar Investment Management’s managed-account engine builds the savings rate and investment recommendations for the participant during accumulation, the managed-account drawdown strategy builds guidance for decumulation. “We look across various savings buckets, Social Security and spousal assets, to build a monthly spending strategy,” Voris said.
Though the offering currently does not utilize guaranteed income as a building block, it could easily incorporate annuities, Voris said. “Morningstar Investment Management is a leading engine in determining how to allocate to guaranteed income. We have the infrastructure to meet many of the needs of sponsors and the record keepers,” he noted, adding that its service can integrate a single premium immediate annuity, which is available today.
When it comes to evaluating different investment products, Callan’s Ungerman said plan sponsors need to carefully look under the hood. “This is where the pain points are most likely to arise. Sponsors should understand the various annuity structures, different riders, mortality risk and how the product addresses inflation.” Broader interest rate and capital market considerations need to be considered, as well as issues like portability, liquidity, counterparty risk and insurer solvency, he said. Callan consults with plan sponsors across all these aspects as part of the evaluation process.
One risk that is less talked about is “lapse rates,” Ungerman said, which “calculates how many participants actually stay and follow through with a deferred annuity or give up before the payoff. That optionality can come at a significant cost. They may have overpaid for a benefit down the road before deciding to switch gears.”
Callan also stress-tests products by quantitatively modeling different scenarios, he added. This helps plan sponsors better understand the opportunity costs, fees and the positives and negatives of each income solution, whether integrated annuities or managed accounts. “We want to make sure that when a plan sponsor offers a new product in their plan, it’s been very well thought out and is consistent with the plan sponsor’s objectives for their participants,” Ungerman said.
What Drives Success?
Defined contribution plans can work on crafting a better instrument that delivers retirement income, but it will be meaningless if participants don’t understand it or use it. While a majority of participants are used to the default solution in the accumulation phase, retirement income requires active choices by participants. Participant engagement and education is therefore key to the success of a retirement income program.
Suitability of the retirement investment offering for a plan’s population is the starting point for evaluation, said Morningstar Investment Management’s Platz. “What are the plan’s demographics? Are the employees young? Do they have access to a DB plan?”
Platz cautioned, “Many plans do not have the internal processes to analyze the suitability of a product, let alone to make sure that the product continues to be appropriate for their participants.” In addition, DC plans are increasingly taking a long-term perspective when evaluating different investment options.
Success very much depends upon participant engagement, added his colleague Voris. “Offering a high-quality digital experience, phone counseling or in-person guidance is critical to driving engagement.”
Voris sees room for both guaranteed and nonguaranteed products in the years ahead, with personalized advice and engagement underpinning the success of both approaches. “Our ability to engage in a personalized way is critical to helping provide people with managed spending and income guidance.”
Retirement income solutions help employers with recruitment, retention and allowing employees to retire on time. “A lot of companies are dealing with ‘reluctant retirees,’ who work beyond their expected retirement age because of financial fears,” Nuveen’s McCarthy said. Guaranteed solutions can provide the certainty and income that participants require to retire on time.
He cited three considerations as top of mind for sponsors evaluating solutions: “Will the participant utilize it? Will the solution help my employees during retirement? Will the solution enhance my overall benefits offering?”
In terms of utilization, McCarthy noted that many retirement offerings, despite extensive planning, design and communications efforts, end up with low adoption rates, which can be frustrating for some DC sponsors who want to see higher uptake. “That is why we are seeing a tilt towards integrated income solutions. They tend to have higher adoption rates.”
Solutions incorporating annuities provide guaranteed lifetime income, which reduces the participant’s likelihood of running out of money, a key consideration from a plan sponsor fiduciary standpoint, McCarthy said. “Americans are living longer, and 40% are at risk of running out of income in retirement. The solution solves for longevity risk.”
In-plan annuity solutions present additional decisions for plan sponsors. “The key difference from selecting regular plan investments is the additional step of assessing the suitability of the income solution and then evaluating available options. Working with their retirement plan consultant can help plans to navigate that course,” he said.
Looking ahead, McCarthy said improved record-keeping technology and enhanced 401(k) design can accelerate the adoption of lifetime income solutions. “The industry needs to embrace a 401(k) plan design that gives employers the ability to provide their employees with the option of pension-like guaranteed income.”
For plans considering different retirement income offerings, the low hanging fruit is to choose from solutions already being offered by their record keeper, said Callan’s Greg Ungerman. A key reason for this, he pointed out, is the record keeper’s connection to the participant; “that is the main channel for communication and education for the participant. It is a critical juncture. If products don’t connect with the participant, that becomes problematic for the success of a program.”
The variability in retirement income adoption is determined less by plan size or industry sector and more by the capabilities of the record keeper, said State Street Global Advisors’ Veneruso. “Adoption will come first for plans that have a record keeper familiar with retirement income solutions,” while others may be waiting for their record keeper to build out their platform for implementation, he said. “The greatest pain point is not having the solution seamlessly integrated into the participant experience, which is typically owned by the record keeper.”
DC sponsors need to continue to help drive record keepers to prioritize the building out of integrated solutions, he noted, as it is critical to a successful participant communication and engagement strategy. “Ultimately, the record keeper is the gatekeeper to the participants. A solutions provider needs to be able to work hand in hand with the record keeper to provide participants with education.”
According to Veneruso, the goal of education is to get participants to the point where they can make an informed decision about in-plan retirement income, which he sees as a feasible goal. “Retirees have to make choices about Social Security and Medicare. This is another choice they’ll have to make,” he said.
A variety of approaches are required to engage participants. “Don’t just rely on an email strategy or a print strategy. Participants are unique, even within the same company,” Veneruso noted. For example, one DC plan client had offered on-site education but was seeing large gaps in response rates. That was because many employees worked night shifts and didn’t have access to lunchtime participant education. “Having knowledge of your participant base’s work patterns and being flexible is key to driving participant engagement,” he said.
Looking ahead, Veneruso said technology will continue to drive educational offerings. “We’re starting to see more bespoke advice. Providers will use technology to make it easier and more cost effective to get advice to participants.”
Ultimately, the success of retirement income will depend on ensuring that participants are making educated decisions, Veneruso said. “The subtle differences in your investment mousetrap are not where you’re differentiating, it’s how you are communicating to participants who have to make these decisions and live with them in retirement.”