As the conversation about retirement readiness expands to address what happens after retirement, plan sponsors must face a host of pros and cons, as well as regulatory issues surrounding income-related products. According to Christopher Jones, chief investment officer (CIO) and executive vice president of investment management at Financial Engines, one concern of plan sponsors is how difficult it might be to unwind a specific income product or bring it outside the plan if they decide there is a better choice.
Fiduciary lock-in is a core issue that creates some rejection of these products, Jones said. The issue of guarantee does answer longevity protection, Jones said, and certainly annuities are an important piece in reaching a solution. But this doesn’t necessarily mean the product must be in the plan.
One possibility is a managed account that allows for an annuity purchase to take place outside the plan, so that a plan sponsor can offer access to a stable income stream without having to put insurance into the plan, a solution that can appeal to both the participant and the plan sponsor. A key difference is that this solution does not make the decision of when to annuitize, Jones said. “Very few people are comfortable annuitizing,” he said, because of behavioral reasons and safety concerns. “People are unwilling to translate an account balance into an income stream.” Later, when they’ve had a chance to acclimatize to retirement, perhaps in their 70s, they are much more likely to see the benefit of longevity protection.
The reality is, Jones said, not every person should have everything annuitized. “If a household needs more annual income, the best way to do that is to buy more Social Security income. Defer the start date of your benefits and significantly increase the amount of payments—it’s a screamingly good deal, better than private insurance companies. Annuities are a core component and can be efficient and appropriate, but there are other ways to annuitize.”
“How is the average participant supposed to understand this whole concept of retirement income?” asked Michael Perry, president of Retirement Advisors LLC. “We’ve done a great job educating participants during the accumulation phase,” he pointed out. “We educated them very well on how to construct a portfolio based on their individual tolerance for risk. Now we want them to pay extra for a different idea 10 years away from retirement. We want them to be more aggressive when they’re scared or less aggressive, depending on what they chose.”
Finding a Fit
David Kaleda, principal at Groom Law Group, weighed possible concerns plan sponsors should have about their responsibility under the tax code of the Employee Retirement Income Security Act (ERISA). “I think the current rule construct does work,” he said. “Even guaranteed products could fit in the current scheme. It doesn’t fit neatly, and some would argue it doesn’t fit well.”
One issue is the shift in thinking that has taken place since the rules were put in place, Kaleda says. Accumulation—snowballing into the biggest possible account balance—was the main point when the rules were put into place, with very little focus on the concept of decumulation. How participants should spend this money, and how they should make it last simply were not at the forefront of regulators’ and others’ thinking.
As an example, Kaleda pointed to the safe harbor regulations for qualified default investment alternatives (QDIAs). “Some people believe you could make the argument that a lot of guaranteed products and managed account products will fall under the QDIA,” he said. “I’ve heard from plan sponsors they would rather see an actual safe harbor built in.”
Kaleda said the constant struggle plan sponsors face—that tussle between advice and education—is another issue. Plan sponsors so often ask if they are giving education or advice, he said. “The general rule is, plan sponsors are willing to be fiduciaries in a lot of places, but not with respect to providing information on specific retirement income solutions,” he said. “They don't want to be investment advice providers to their participants.”
Plan sponsors want to know, if they offer something with an insurance product in the plan, what the impact would be on their fiduciary duty? “The kicker is that the regulations are focused on situations where the plan sponsor fiduciary is making the decision to annuitize or purchase a product that is insurance just one time,” he said. “Once the decision is made, the person is outside the ERISA system and plan sponsors don’t have to worry,” Kaleda pointed out.
On tax issues, Kaleda pointed to the recent guidance on qualifying longevity annuity contracts (QLACs). “If we have a deferred income annuity feature within a plan, also known as a QLAC, the Treasury Department said you could implement those and not run into required minimum distribution problems,” he said. “Whenever you add features like this, you always have to consider the tax ramifications as well as ERISA.”