The Markets July 13, 2022

Retirement Income Evolution

Experts agree that few defined contribution retirement plan participants can successfully manage their retirement spending on their own, meaning it is crucial for advisers and providers to help solve the ‘decumulation challenge.’
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Art by Jeffrey Kam


In 2022, as stock markets nosedived, inflation hit fresh highs and expectations for economic growth declined, many investors were reminded of a risk they face that tends to be forgotten during the good times: How will they make their money stretch over a longer life span, and potentially with a much higher cost of living than expected? 

Over the past 40 years, as defined contribution plans replaced defined benefit plans, individuals were asked to shoulder their own investment and longevity risk. They were left to solve for retirement income by themselves, relying on market infrastructure, tools and support that has traditionally been focused on the accumulation phase.

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Joe Boan, a veteran of the retirement industry and managing director of distribution and business development for Annexus Retirement Solutions, says the industry is at an income inflection point.

“As an industry, we have been trying to solve the guaranteed income problem with little success,” Boan says. “If we really want to drive better participant outcomes, then we need to accept that the reality is that people want income. That is what the desired outcome should be.”

Progress has been made, sources agree, but survey research shows this vision is still a long way from reality. Today, some 85% of DC plan participants wish their employer’s retirement plan had an option to help generate income in retirement. Meanwhile, eight in 10 plan sponsors agree that participants need in-plan income options, according to Greenwald Research’s 2021 In-Plan Insights Program.

Overall, 75% of participants prefer income stability over principal preservation, according to research conducted by the Employee Benefit Research Institute in 2020. Yet only about 10% of company-sponsored plans offer annuities.   

Boan and others say this is changing, though, and that retirement income’s moment may have finally arrived. Slowly but surely, more income options by more providers are being offered inside company plans. This represents an evolution in the industry and, as some have pointed out, a transformation of 401(k)s from saving vehicles into retirement income plans.

More Income Options as the Market Evolves

Wade Pfau, a professor at the American College of Financial Services and the author of “The Retirement Planning Guidebook,” says the passing of the SECURE Act in 2019 was a turning point for income.

“With the SECURE Act, we are seeing more options developed that are focused on retirement income and not just the accumulation phase,” he says. The law provides “safe-harbor” protections for companies that offer annuities inside retirement plans. In 2022, a bill was re-introduced that would help even more employers benefit from the safe harbor.

“Before, an employer plan was taking on a lot of risk if they offered an annuity. It’s a good development that employers can now provide retirement income options without taking on a whole new level of responsibility,” he says. “Effectively, plans can offer approaches more aligned with defined benefit pensions once again, instead of defined contribution.”

Pfau’s recent research has been focused on four retirement income styles he has identified: 

  • A total-return style pushed by many registered investment advisers. In the decumulation phase, the focus here is on taking distributions and generating income from diversified investments.
  • A time-segmentation approach, in which retirees use investments for retirement. They cover short-term expenses with bonds and leave stocks for long-term expenses.
  • An income-protection style, which provides a floor of income, such as through an annuity, with additional funds invested.
  • A risk-wrap approach, in which investors have a protected income floor, for instance through a variable annuity, but they can still invest for upside gains and maintain some liquidity.

Pfau’s research shows that only a third of the population has a retirement income style that resonates with the total-return approach, though it is the most popular with advisers.

“If that’s the only option that a 401(k) plan offers, it’s an option that only appeals to about a third of the population,” he says.

Evolution in Compensation Models for Out-of-Plan Annuities

Individual adviser commission structures have played a role over the long term, too, putting the emphasis on accumulation instead of decumulation. Fee structures based on assets under management incentivize investment managers to keep as much as possible in the portfolio. If advisers sell an annuity to generate retirement income, that potentially damages the adviser’s practice by lowering AUM, Pfau notes. 

Now, however, annuity providers are offering fee-based annuities that allow investment managers to earn compensation on assets held within an annuity.

“If I’m managing $1 million for a client, and I charge a 1% fee on that, I can now also charge that 1% fee on the value of the annuity,” Pfau explains.

New Initiatives and Focus on Retirement Income

Other initiatives show what Pfau describes as a “slow evolution” of the market to meet unaddressed needs around advice, education and structures to support decumulation and retirement income. They include new industry consortiums and a research initiative by the Organization for Economic Cooperation and Development focused on how to improve the certainty of income. The OECD has also issued a formal recommendation for DC plans to include lifetime incomes by default by pooling longevity risk among participants.

TIAA, as another example, is working to educate the public, advisers and plan participants about their options to secure guaranteed lifetime income. A provider of in-plan annuities, it published a paper in June 2022 about them called “Separating facts from perception: The valuable role that in-plan annuities can play in retirement SECURE-ity.”

Tamiko Toland, head of lifetime income strategy and market intelligence at TIAA, says the approach to income should be fundamentally different than the way the industry has traditionally viewed accumulation.

“’People need an income strategy,” Toland says. “We want people to stop thinking that if they have a certain amount in the bank, they’ll be OK. With the swings of the market, a systematic-withdrawal strategy isn’t safe. We are in the middle of a major evolution of the 401(k). It was never designed to replace a pension. We are seeing a technical and philosophical retooling of the 401(k) to meet that purpose.”

Interest in embedding annuity solutions into plans has also taken the form of new financially engineered products.

In 2018, TIAA launched RetirePlus, a way for plan sponsors and consultants to create models that include guaranteed income investments within a target-date-like structure. This year, RetirePlus surpassed $10 billion in assets, the company says. Now TIAA is offering guaranteed lifetime income solutions to the corporate 401(k) retirement market.

Another provider of an income approach is Annexus. It has created a product that works the same way a traditional target-date fund would work, except that it is combined with a group fixed annuity. State Street Global Advisors will manage the solution’s underlying assets and provide the index for the group fixed indexed annuity. Annexus’ Boan notes that, instead of owning equities and fixed income in a target-date fund, participants own equities, fixed income and shares of a group fixed annuity.

The Income Vision

What’s the vision for those who want to see more focus on decumulation? For Pfau, the vision is for people to have options that fit their retirement income style, regardless of which style they have.

Boan would like to see retirement income solutions become mainstream and used as defaults in plans.

“How to move from non-income generating solutions to income-generating solutions should be a core talking point for every plan and all advisers in the market,” he says. “It was a turning point when target-date funds became the default option. When income solutions become the default option in plans, that’s when we’ll really see the industry take off.”

Compliance July 8, 2022

PBGC’s Final Union Pension Relief Rule Praised—and Questioned

Sources agree that the final updates made to the Special Financial Assistance program for severely stressed union pensions are helpful, but some are concerned about the expanded ability to invest relief funds in potentially volatile equities.
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On July 6, the Pension Benefit Guaranty Corporation, the federally chartered public corporation tasked with insuring Americans’ pension benefits, issued the final rule implementing the American Rescue Plan Act of 2021’s Special Financial Assistance program.

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The moment came as a great relief for many retirement industry practitioners who had long been lobbying for the program, which is designed to provide financial relief to the most severely underfunded union pension programs across the country. But Wednesday’s developments were arguably even more gladly received by the hundreds of thousands of union pensioners and their families, who stood to lose as much as 40% of their promised pension payments.

While the program had been operating on an interim basis, sources agree that the finalization of the rule is a critical step for the program and its beneficiaries. Additionally, the final rule includes significant changes compared with the interim program, and while some of the updates are viewed favorably by the vast majority of stakeholders, others have raised questions that warrant consideration.

The Key SFA Program Changes

According to the PBGC, there are multiple important policy differences between the interim final rule and the final rule. For example, one change addresses the amount of Special Financial Assistance needed to better achieve the goal of allowing plans to remain solvent until 2051.

Initially, the interim final rule applied a single rate of return included in the statute that is higher than could be expected for SFA funds given that they were required to be invested exclusively in safe, but low-return, investment-grade fixed-income products. The final rule uses two different rates of return for SFA and non-SFA assets, so that the interest rate for SFA assets is more realistic given the investment limitations on these funds.

Another change in the final rule allows up to 33% of SFA to be invested in return-seeking assets that are projected to allow plans to receive a higher rate of return on their investments than under the interim final rule, subject to certain protections. Namely, this portion of plans’ SFA funds generally must be invested in publicly traded assets on liquid markets to ensure responsible stewardship of federal funds. These return-seeking investments include equities, equity funds and bonds. The other 67% of SFA funds must be invested in investment-grade fixed-income products.

The third major change is meant to ensure plans can confidently restore both past and future benefits and enter 2051 with rising assets. PBGC designed the final rule to ensure that no “MPRA plan”—a group of fewer than 20 multiemployer plans that remained solvent by cutting benefits pursuant to the Multiemployer Pension Reform Act of 2014—was forced to choose between restoring its benefit payments to previous levels and remaining indefinitely solvent. Instead, the final rule ensures that all MPRA plans avoid this dilemma, supporting them with enough assistance so that these plans can both restore benefits and be projected to remain indefinitely solvent going into 2051.

An Attorney’s Analysis

One experienced pension attorney to have already analyzed the regulation, at least on a preliminary basis, is Rob Projansky, who is co-chair of the employee benefits and executive compensation group at Proskauer. Projansky has experience advising both multiemployer union plans and single employer clients on all issues related to the legal compliance and tax-qualification.

In Projansky’s view, the updates made to the SFA program are, generally speaking, well considered and useful from the perspective of allowing the program to more expressly achieve the goals set out by Congress in the ARPA legislation. He told PLANADVISER that the program has already been functioning relatively well as a procedural matter.

Specifically, 27 applications for relief have been approved under the interim program, with $6.7 billion requested for the benefit of more than 127,500 participants. There are 13 additional pending applications already under review, seeking relief to the tune of $36.9 billion on behalf of some 404,800 participants. 

“I think these changes are being viewed positively, for the most part,” Projansky says. “Before Wednesday, there was real concern about the interim final rule potentially producing some outcomes that weren’t consistent with the intent of the ARPA. At an absolute minimum, the express goal of the statute was to provide enough money to these stressed pensions so that they could last at least through 2051. Because of some technicalities in the interim program that have now been cleared up, there were a number of plans that were, potentially, going to receive relief that was not sufficient to make it to 2051. That would not have been a good or intended outcome.”

The issue is technical, but in basic terms, one problem with the interim relief rules was that the amount of assistance for a given plan was to be calculated based on certain rates of return that investment practitioners viewed as being excessive. These rates of return were seen to be in excess of what was actually possible for a plan receiving relief, given that the regulations also significantly limited the ability of stressed pensions to invest the relief funds in return-seeking assets. This is why the final rules include different (i.e., more favorable for the plans) assumed rates of returns to be used in the calculation of relief payments.

“This was an issue that was the topic of many of the comment letters that were sent to the PBGC, and to their credit, they have taken the market’s feedback and, in our view, improved the system and brought it closer into alignment with what Congress had envisioned,” Projansky says. “This is the purpose of the notice, comment and final proposal system of regulation. The government should, and it did, consider these comments.”

Commenting on the rule change that allows pensions to invest up to a third of the relief assets in return-seeking publicly traded equities, Projansky called it a “reasonable compromise.”

“I think the PBGC recognized the need to balance the security and protection of these assets with the real need for these plans to be generating a reasonable rate of return that supports their long-term stability,” he says. “Under the final rules, plans can modestly increase their return expectations with little to no additional risk, which is what a number of commentators wanted. The PBGC had said previously that it recognized that it had taken a very conservative position regarding the investment of SFA funds, and that the statute indeed gave more room than that.”

Projansky says another technical but important change impacts those plans that had already enacted a MPRA benefits reduction. In basic terms, under the interim rules, certain plans that had already enacted MPRA-authorized reductions might actually be in a better position if it maintained the benefit cuts rather than restored them via the interim relief program. This is because the interim program rules only gave plans enough to keep them  solvent through 2051 whereas MPRA would have kept them insolvent indefinitely.

“So, certain plans with suspensions already in place were put in the unenviable position of potentially having to reject the new source of support in order to keep their plan solvent for longer,” Projansky says. “This conflict was the subject of a lot of comments, as well, and the PBGC has made some important changes to solve this issue.”

Points of Concern

Russell Kamp, managing director at Ryan ALM, has more questions and concerns about the finalized framework.

For context, Ryan ALM’s stated mission is to solve liability-driven problems faced by pensions and other institutional investors through the provision of “low-cost, low-risk solutions.” Kamp himself was on the team of government and industry professionals that drafted the Butch Lewis Act, which was used as the legislative framework for the relief program.

Kamp says the most important development is that all 18 MPRA plans that “reconfigured” benefits will be made whole, enabling pension funds to restore previous levels of benefits without driving these plans back into insolvency.

“That is great news for all of the participants in those plans and the highlight of this announcement,” Kamp says. “The other two areas addressed in this release are the return on assets/discount rates and the permissible investments. With regard to the discount rate, the release states that there will now be two ROAs, with one for the SFA and one for the non-SFA assets.”

Kamp says this framework, from his point of view, is a head-scratcher.

“We don’t need two ROAs,” he says. “We need [more generous] discount rates! We need a different discount rate which determines the size of the Special Financial Assistance grant. It doesn’t matter what the SFA assets earn, as they should be used to defease and secure the promised benefits.”

Kamp says he is “really disappointed” to see that the PBGC is expanding the potential investments for SFA funds beyond bonds.

“If 2022 has shown us anything, it is that markets can go down and go down severely,” he warns. “How does one secure the promised benefits to 2051 by allowing equities that can’t defease liabilities? The sequencing of cash flows and returns is critically important to this process. Yes, equities will outperform bonds roughly 80% of the time over 10-year periods, but what happens if the U.S. falls into either stagflation or recession in the near term that dramatically reduces equity valuations? There won’t be enough left in the SFA bucket to meet the 2051 promises. Permitting only 33% is better than 100%, but they should have kept the original mandate.”

Kamp says he fears that the PGGC has overcomplicated these matters.

“All they had to do was lower the discount rate for determining the SFA grant from the current ‘third segment plus 200 bps’ rule to using all three segments under the Pension Protection Act, with no additional hurdle,” Kamp says. “And, they must ensure that the promised benefits are met by mandating that asset cash flows in the SFA be used to defease liability cash flows, which would allow for a more risky asset allocation in the legacy asset bucket to meet future liabilities beyond 2051. These are three easy steps to securing the benefits, while keeping these plans viable for current employees and those that will join in the years to come.”

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