Defined contribution (DC) retirement plan participants strongly value their workplace retirement
plan and would like to see their employers do more to help them save because,
looking back on their savings history, they regret not doing more to prepare
for retirement. These were the main findings of an American Century Investments
survey of 1,504 full-time workers conducted by Matthew Greenwald in the first
quarter.
Seventy percent think their company should automatically enroll them at a 6%
deferral rate, and 75% said that if given a choice between a salary increase
and a comparable company match, they would take the match. Eighty percent would
prefer a 100% company match on their first 3% contribution to their retirement
plan rather than a 3% salary increase.
Respondents said the first five years of their working lives
is the period of time for which they have the most regret, having put off
saving due to not earning enough, having to pay off debts and incurring
unexpected expenses. Ninety percent said they would like to have told their
younger selves to save more; however, 70% said they would listen to their
future selves. Participants are also five times more likely to believe it is
worse to have too little money in retirement than to miss out on something today.
Eighty percent want at least a “slight nudge” from their
employers to save for retirement. More than 50% think employers should
re-enroll participants, 70% would accept auto escalation and 70% support
re-enrollment into target-date solutions.
More than 80% said having a retirement plan makes them
feel better about working for their employer, and 75% said that if given a
choice between two employers, one with a retirement plan and the other without
one, they would select the employer with the retirement plan—even if the salary
offering was 5% higher at the company without a retirement plan.
“Plan participants told us that, without a doubt, they would
be in much worse shape without access to an employer-sponsored plan,” says
Diane Gallagher, vice president, practice management, at American Century
Investments. “Nearly all express regrets about their personal savings habits,
which says to us that employers have the opportunity to structure plans that
can help drive more effective retirement preparations for their employees. Although
plan sponsors may be reluctant to put into place aggressive defaults or
automatic programs for fear of employee backlash, our research shows that
participants are actually in favor of these types of measures. In essence,
employers have the keys to the kingdom.”
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Research Offers Framework for Retirement Income Solutions in DC Plans
Researchers suggests several strategies for helping DC plan participants generate retirement income and discuss what plan advisers and sponsors should consider to select the right one.
The next step in the transition
from defined benefit to defined contribution (DC) retirement plans is
for DC plans to offer retirement income programs that retirees can use
to convert their account balances to periodic retirement income, the
Stanford Center on Longevity and the Society of Actuaries Committee on
Post-Retirement Needs and Risks say in a research paper.
The
research report helps plan sponsors, advisers, and retirees achieve this
goal by demonstrating an analytical framework and criteria for helping
them evaluate and compare a variety of possible retirement income
solutions. The goal is to further understanding about how to use various
retirement income generators (RIGs) to meet specific retirement
planning goals.
The Society of Actuaries and the Stanford Center
on Longevity analyzed retirement income generators and found there are
several ways for DC plans, advisers and participants to approach
lifetime retirement income.
The first strategy focuses on
straightforward RIGs that can currently be made available in DC plans,
including single premium immediate annuities (SPIAs), guaranteed
lifetime withdrawal benefit (GLWB) annuities, and systematic withdrawal
plans (SWPs) using invested assets. Within a DC retirement plan, an SWP
can be implemented as an administrative feature using the plan’s
investment funds.
The report notes that SPIAs provide higher
expected lifetime retirement income than investing approaches that
self-fund longevity risk. As a result, dedicating more savings to
annuities guarantees that retirees cannot outlive their income and
increases expected lifetime retirement income. But devoting savings to
annuities reduces accessible wealth and potential inheritances
throughout retirement.
RIGs that invest savings provide access to
unused savings throughout retirement, whereas annuities generally do
not provide such access. As a result, dedicating more savings to
investing solutions increases accessible wealth and potential
inheritances, but decreases expected lifetime retirement income. Having
access to savings provides flexibility and the ability to make
mid-course corrections throughout retirements that can last 20 to 30
years or more. Note, however, that there will be no further income and
no accessible wealth and inheritances if retirees outlive their savings
due to living a long time and/or poor investment experience.
GLWBs
are hybrid solutions that both guarantee lifetime retirement income
through longevity pooling and provide access to savings. These products
project less lifetime retirement income than SPIAs and less accessible
wealth than pure SWP strategies, but may represent a reasonable
compromise between competing retirement income goals.
NEXT: Other retirement income strategies
The second strategy—using
retirement savings to enable delaying Social Security benefits—increases
projected average retirement incomes for all retirement income
solutions studied, the report notes. Researchers’ projections assumed
retirement at age 65, with the retiree withdrawing from savings the
amounts sufficient to replace the Social Security benefits that are
being delayed to age 70. The estimated amounts needed to replace Social
Security benefits between ages 65 and 70 were assumed to be set aside at
age 65 and invested in cash investments.
The third strategy is
to combine qualified longevity annuity contracts (QLACs) with SWPs. A
QLAC is a type of deferred income annuity (DIA) that delays the start of
income until an advanced age such as 80 or 85. The potential attraction
of a strategy that combines SWPs and QLACs is to try to realize the
best features of both systematic withdrawals and annuities. To achieve
this goal, a large portion of assets remain invested to generate
retirement income and are accessible and liquid. A relatively small
portion of initial assets are devoted to the QLAC to guarantee a
lifetime payout, no matter how long the retiree lives.
The report
notes key challenges of the third strategy for retirees and their
advisers including determining the percentage of initial assets devoted
to the QLAC; developing an SWP withdrawal and asset allocation approach
that minimizes disruptions in the amount of income between ages 84 and
85; and deciding whether to purchase a QLAC that pays a death benefit
before age 85, producing lower retirement income.
Key challenges and decisions for plan sponsors include:
QLACs
pose communication challenges due to the potential for disruptions in
income between ages 84 and 85, and if there is no pre-85 death benefit.
Should
plan sponsors just make QLACs available to plan participants and their
advisers to utilize on their own, or should they attempt to package SWPs
and QLACs into an integrated retirement income solution for retirees to
elect?
Any type of annuity presents a challenge to explain to
participants, and QLACs may provide an additional communications
challenge. Due to the complexity of QLACs, plan sponsors who offer QLACs
may want to offer the option for accessing financial advisers who are
qualified to provide advice on QLACs.
NEXT: Strategies to protect retirement income before retirement
The researchers analyzed the following strategies to protect retirement income in the period leading up to retirement:
Invest
in target-date funds (TDFs) that reduce exposure to stocks as the
worker ages, then employ a systematic withdrawal plan (SWP) to generate
retirement income;
Buy deferred income annuities (DIAs); and
Invest in guaranteed lifetime withdrawal benefit (GLWB) annuities.
The
researchers noted that TDFs remain vulnerable to stock market crashes
and may not offer down-market protection in the period leading up to
retirement. Their projections show that fixed DIAs offer the best
protection against the possibility that an unfavorable economic scenario
will result in retirement income being much less than expected,
compared to the other RIGs and strategies analyzed. DIAs deployed at age
55 offer the most protection, although a laddered approach (purchasing
small amounts of a DIA each year) produces projected results that are
almost as favorable as buying the DIA at age 55.
However, the
paper notes, many workers will not want to invest all their savings in a
DIA, since a DIA does not have liquidity throughout retirement, a
desirable feature of SWPs. In addition, using a DIA results in reduced
upside potential when market returns are favorable, compared to using
TDFs with SWPs.
An alternative to investing in a DIA during the
period leading up to retirement is to invest a portion of retirement
savings to intermediate and long-term bonds (or mutual funds), and then
purchase a single premium immediate annuity (SPIA) at retirement. The
goal is the appreciation or depreciation in these assets due to interest
rate changes will be approximately the same magnitude as related
changes in annuity pricing. Such a strategy requires sophistication from
a near retiree (or an adviser) and may not deliver the same eventual
income as a DIA. However, this strategy may give the near retiree more
flexibility and liquidity, particularly if the near retiree is uncertain
about the timing of retirement.
NEXT: Considerations for plan sponsors and advisers
When designing a retirement income program, DC plan sponsors will
want to weigh the administrative and communication burdens of various
RIGs and retirement income solutions versus their potential advantages,
the researchers say. DC plan sponsors could help meet the varying goals
of participants by starting with a straightforward retirement income
program that offers the following basic RIGs:
The ability to purchase SPIAs that are fixed, inflation adjusted, or adjusted by a growth factor such as 3%;
An
installment payment feature that implements a SWP with a few different
withdrawal strategies, together with a few different funds with varying
asset allocations;
Withdrawal strategies could be the Internal
Revenue Service (IRS) required minimum distribution (RMD), or use fixed
percentages such as 3%, 4%, 5%, or 6%. As a practical matter for
tax-qualified plans, after age 70-1/2 the RMD would override the fixed
percentage if the RMD results in a higher withdrawal amount; and
A period certain payout to enable delaying Social Security benefits.
A basic retirement income program could also help by packaging retirement income solutions. A few examples are:
A
handful of packaged combinations of SPIAs and SWPs together with
appropriate investment funds, for retirees who want to choose among a
limited menu of solutions;
The ability to custom-mix SPIAs and SWPs in whole percentages, for “do-it-yourselfers” or individuals working with advisers; and
A designed default retirement income solution that might meet the needs of many employees.
The researchers note that the above RIGs and packaged retirement income solutions are readily available to most DC plans.
The
analyses in the report can be used by financial institutions and
advisers to help form recommendations for constructing retirement income
portfolios that are in the best interest of their clients who are close
to or in retirement. Advisers and financial institutions can best serve
their clients if they’re able to recommend diversified retirement
income portfolios with the potential to be allocated among different
common retirement income classes, including Social Security benefits,
invested assets, and annuities. Other assets and resources such as home
equity and continued work might also be considered.
Ideally,
financial institutions and advisers will want to understand each
client’s goals and circumstances that can influence the retirement
income allocation decision, including:
The desired amount of retirement income expected throughout retirement;
The expected pattern of change in retirement income over time, for example, to keep pace with inflation;
The
amount of protection that’s needed against decreases in retirement
income due to investment losses and interest rate changes;
The portion of income that the retiree wants to be guaranteed for life, no matter how long the retiree lives;
The current health status and life expectancy of the retiree and spouse/partner, if applicable;
The
desired protection against the threat of long-term care, and the
potential influence on the retirement income allocation decision;
The specific needs and desires for liquidity and access to savings throughout retirement; and
The retiree’s desires to leave a legacy upon death.
Each
of these goals has the potential to conflict with other goals, so an
important task for the adviser is to help the retiree prioritize and
make tradeoffs among competing goals, the report says.