The Markets August 4, 2015

A 60/40 Approach to Decumulation

Experts suggest a “portfolio” approach can be an adaptable and effective means of controlling retirement spending.
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The decumulation phase challenges both users and providers of retirement plan services, explains Steve Vernon, a consulting research scholar at the Stanford Center on Longevity and a former actuary.

He says the Center for Longevity has tested a “portfolio” strategy for directing the drawdown of retirement assets—with good results. The strategy involves a participant building “a floor consisting of one or more sources of guaranteed income—Social Security, a pension, maybe an annuity—which won’t go down with the stock market and will last as long as you do,” he says.

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Money from the secured portion of the portfolio should be earmarked to cover basic living expenses. The rest of the participant’s savings can be invested aggressively and used at discretion, say for travel, hobbies or gifts, says Vernon, who is also a retirement adviser at the nonprofit Institutional Retirement Income Council. This strategy resembles a traditional 60/40 investment portfolio of stocks and bonds, except that the bond portion is now a guaranteed lifetime income source.

This is especially effective when the market plummets, he says. Withdrawing money from investments in decline is “the worst thing you can do. The floor psychologically helps people. They can let the money ride.”

Plan sponsors can facilitate the approach, he says, by offering an annuity through the plan and educating employees about how the strategy works and how it can be implemented.

To plan sponsors that have simply put off adding a product because they’re waiting for the market to evolve, Vernon says his advice to this group is that “there are plenty of good, credible ways now to generate retirement income. Not to say there might not be more innovation in the future, but there are robust offerings now, and plan sponsors that are motivated don’t have to wait.”

NEXT: Insurance pros and cons 

Basically, what plans have to choose from are deferred and immediate annuities, with fixed or variable payments—the latter, in some products, adjusted for inflation. Each manages risk in a different way. “I’d want to walk through with my client the risks the participants face in retirement, and how each of those products and services addresses those risks,” adds Bruce Ashton, a partner in the employee benefits and executive compensation practice group at Drinker Biddle & Reath LLP says.

“The insurance companies have been fairly innovative in developing insurance features that could be placed inside a plan,” says Vernon. A popular option is the guaranteed lifetime withdrawal benefit (GLWB), or guaranteed minimum withdrawal benefit (GMWB), Prudential’s IncomeFlex series being an example, he says. This provides monthly payments but gives the participant more flexibility and control than does an annuity.

Stewart Lawrence, senior vice president and national retirement practice leader with The Segal Group, says of the annuity products available, he likes longevity/deferred annuities, which generally begin to pay out when the retiree reaches 85. Today’s low interest rates make these expensive, though, he says. Assuming that rates will climb, a retiree could spread out the purchase—five payments over five years—to average out the cost. Keep in mind, however, that this will mean five execution fees, versus just the one, Lawrence says.

Lawrence is less impressed with immediate lifetime annuities, which he describes as the opposite of life insurance: Make one grand payment and immediately begin to receive small payments back. “The purchase of one requires irrevocably locking up a large amount of capital—perhaps $15 to $20 per $1 of annual annuity.”

NEXT: Products outside the plan

The plan sponsor should also investigate products available outside the plan, as well. Vernon likes managed payout funds, a systematic withdrawal strategy offered by most mutual funds. “Those might be good for someone who has money in an IRA and doesn’t want to think hard about it. You set up an IRA with Vanguard and say, ‘I want to put my money into a managed payout fund.’ Vanguard will say, ‘Tell us where to send the check.’ They automatically send a check every month and will do the asset allocation for you.”

Performing asset allocation is an important benefit, Vernon says. “It’s even more critical after retirement, compared with accumulating money before.”

If the strategy itself does not offer this service, the plan adviser can provide it, in the early stages when helping the participant arrive at a personal plan. Because an employee may have several abandoned defined contribution plans and/or IRAs, the adviser could also suggest consolidating them into one—such as the managed payout fund. He should first review the details of each with the participant to ensure the money stays where fees and expenses are most favorable.

Some plan sponsors may wish to hand off all such responsibility, though. For them, the alternative could be an advisory service. Increasingly, plan administrators supply this service, not to mention retirement income solutions, annuity products and communications, Vernon says. “That can be a feature if you’re doing a vendor search for a new plan administrator—what support does the plan administrator have for retirement income?”

Fees will always be an issue to some degree, whether participants are accumulating money or retirees drawing it down. For one final strategy, he suggests that advisers urge their clients to adopt institutionally priced funds whenever they can. “There will always be administrative or investment fees,” he says. “If retirees keep their money in a 401(k) with lower fees, that will make their money last longer.” 

Client Service August 4, 2015

Participants Need Skilled Support on Decumulation

Advisers can add value for their plan sponsor clients by strategizing the participant account drawdown process.
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Suggestions for the best way to draw down a 401(k) account are kind of like suggestions about where to find the best slice of pizza.  

Stewart Lawrence, senior vice president and national retirement practice leader with The Segal Group, says the subject of drawing down retirement savings is one of the most complex and challenging areas of running a 401(k) plan and managing individuals’ wealth. It’s an area where personal tastes and objectives matter significantly, where a one-size fits all approach doesn’t make much sense.

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Even a simplified and well-run 401(k) plan will have a participant population with hugely diverse financial circumstances. As Lawrence puts it, the best drawdown strategy for some may be the worst for others: “Everyone’s situation is different,” he notes, even within a single plan.

Lawrence ticks off just a few of the variables that should help inform individuals’ drawdown strategies, such as the presence or absence of other retirement plans from previous employment; savings accrued in individual retirement accounts (IRAs); anticipated Social Security benefits; a spouse’s income; post-retirement pay; and any Roth features, which can bring fairly complex tax implications. In other cases a participant will have adult children or other family to support, or they may have unique financial objectives that will have to be considered.

Steve Vernon, a retirement adviser at the nonprofit Institutional Retirement Income Council, observes that Bill Sharpe, a previous Nobel Prize winner for economics, often said retirement income planning is “the hardest problem I ever looked at.”

But one cannot just ignore the challenge because it is great. Especially for plan sponsors with a sense of paternalism over their workers’ retirement years, helping participants create a well-structured system of withdrawals seems increasingly important. This means adviser opportunity, according to Lawrence and Vernon, as sponsors want help understanding the array of new products and services targeting this trend.

NEXT: Variables and more variables 

For all the variables across participants reaching the withdrawal stage, two things are definite. First, good options are available in terms of specific products or services to make the drawdown process more controlled. Second, participants need good education to understand such products and to use them properly.

The adviser is ideally suited to provide this guidance, first to the sponsor, helping implement the right strategies, services and tools for its particular work force. Depending on his willingness to take on fiduciary responsibility, the adviser can then turn directly to the participants, helping them choose the best strategy for their individual lives.

“The plan adviser should take on that advice role [with the participants]—the fiduciary role,” says Vernon, who is also a consulting research scholar at the Stanford Center on Longevity. “That’s the value he adds. He should take the time to learn each person’s circumstances and then customize the advice to them.”

In terms of product selection, the sponsor—and ultimately participant—will likely be deciding between two basic approaches. These are systematic withdrawals from previously accumulated assets and various types of annuities—either in- or out-of-plan. The Center on Longevity recommends a combined strategy—what it calls a portfolio approach—that has the participant annuitize some assets while keeping others more liquid.

The adviser, as an unbiased party, can present the pros and cons of each—important because “it becomes tricky to find advisers who don’t have a stake in your financial decision in retirement,” Vernon says. “Often, in this debate over which is the more effective—and secure—alternative, the most vocal advocates for each are selling [that alternative]. So their recommendations are often self-serving.”

NEXT: Right-sizing the risk outlook 

One complicating factor about annuities is the potential for portability issues. But, according to Bruce Ashton, a partner in the employee benefits and executive compensation practice group at Drinker Biddle & Reath LLP, some providers and industry advocacy groups have developed portability protocols, which, if adhered to by the administrator, make transferring a product from one provider to another relatively easy.

Still unresolved are litigation prospects. “The risks plan sponsors are concerned about include what their selection and monitoring obligations are, related to whether the provider offering a product will be around in 30 years,” Ashton says. He points to a safe harbor regulation on the subject, issued by the Department of Labor (DOL), as being problematic, but adds that the agency may revise it. “If and when that comes out, it will also spur more emphasis and more understanding and discussion of the issue,” he says.

With so much complication, what might a typical withdrawal strategy look like? Lawrence shares the scenario of a 65-year-old retiree who chooses to leave his Social Security benefits to ripen until he turns 70. Here, Lawrence applied the 3% rule, which would give the retiree $1,000 to live on each month for that first five years, totaling $60,000. “That’s a fair amount of money, and, for a large percentage of the population, that’s their 401(k) money,” he says. At 70, the retiree would begin taking Social Security and could invest whatever remained of his 401(k).

This example, of course, ignores market whims. Instead of the simplest take on the 3% or 4% rule, where the withdrawal amount is set at retirement and remains flat, “I like taking 3% of whatever’s there in a given year,” Lawrence says. “So if the market crashes, you take 3% of the lower balance and you live on that. It’s a tough year, but when the market goes up, you get a raise every year by taking out the same 3%. Otherwise, you can deplete the account very quickly.”

In either instance, delaying Social Security is key, and plan sponsors can aid their participants merely by explaining how that measure helps.

“For the participant who needs to retire at 65, the sponsor could help him postpone the benefit by adding a temporary payout feature to the plan,” Vernon says. This systematic withdrawal scheme would last for five years, paying him the monthly amount Social Security would when he reached 70. “By setting that up administratively and making it easy for the participant to check the box and implement, the sponsor is doing its participants a favor,” he says.

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