Paving the Way

The industry has recognized the need for a while, but the solution has been evasive: How does a plan offer income products to participants without risk, so they can strategically draw down their savings?

“Providers have been trying to ‘solve for’ [this] with an income product, and you can’t do that,” says Barbara Delaney principal and founder of StoneStreet/Renaissance, a part of Hub International, in Pearl River, New York. “You have to solve for it with a process.”

“We’re hearing more from plan sponsors about the need for and interest in retirement income solutions,” says Joel Schiffman, head of intermediary distribution at Schroders in New York City. “I think the challenge remains, in what direction should they go? It seems everyone’s looking but no one is sure of the right method to take.”

Schiffman notes that since the Setting Every Community Up for Retirement Enhancement Act was passed, there has been a proliferation of retirement income products, but nothing has really caught on at this point. “There’s no silver bullet. I think as products come out and plan sponsors dig deeper, they’ll offer multiple options to plan participants,” he says.

One option is to embed fixed annuities within target-date portfolios, argues Tim Pitney, managing director of institutional investments at TIAA in Shrewsbury, Massachusetts. “You can still get the best of what target-date funds have done during the accumulation phase: helping employees have a better asset allocation. But, additionally, volatility will decrease, thanks to the introduction of annuities in place of bonds during accumulation. There is also the option—not an obligation—to annuitize, thereby allowing people the flexibility to create their own personal pension at retirement,” Pitney says.

Another option is managed accounts, which provide guidance about income streams as part of the solution. These make considerable sense as a way to help participants with their decumulation, says Delaney.

While most consultants and advisory firms prefer to retain retiree assets in the plan, according to the “2022 PIMCO US Defined Contribution Consulting Study,” that study also found that consultants and aggregators diverge on recommended retirement income solutions. Institutional consultants are most likely to recommend target-date funds with regular level payout (64%) or target-date funds with embedded guarantees (48%). Aggregators prefer managed accounts as a retirement income solution (60%), but are also likely to recommend, by 50% for each, in-plan annuities—deferred or immediate or qualified lifetime annuity contracts—or target-date funds with embedded guarantees.

A Personalized Process

People making decisions about their decumulation phase have a critical need for personalized guidance, because individual circumstances differ so much as people approach retirement, says Michael Esselman, vice president of investments for OneDigital Retirement + Wealth in Atlanta. “How do we as an industry address the personalization that these participants need?” he says. “Managed accounts fit that need for product personalization.”

The decumulation phase is more of a continuum rather than a one-time cliff, says Lorianne Pannozzo, senior vice president, workplace personalized planning and advice at Fidelity Investments in Boston. “A managed account is a personalized, integrated investment and financial planning solution. And, when you think about decumulation, that’s the time when some of a person’s factors may change more than they have in the past,” she notes. “That information changes over time, so every year, the managed account[—the portfolio and planning guidance—]could adjust based on how a person’s facts and circumstances have changed.”

For pre-retirees in a managed account, the retirement-planning process usually starts with thinking through their retirement vision. “Before participants can solve for their finances in retirement, they need to understand what they’re going to do in retirement,” Delaney says.

“Where does that person want to live? How does that person want to spend his or her time? Does that person want to work part time in retirement? What does that person want to prioritize financially: spending down the full account balance, or leaving money to his or her kids? A retirement-income solution won’t work unless it also includes helping people understand what issues they [need to address],” she says.

“It can be intimidating at the start, but, for many people, it’s a relief when they’ve put together a plan for their expenses in retirement.”

Managed account services are not just about an investment portfolio or withdrawal rate for participants nearing retirement, says Kelly O’Donnell, executive president and head of workplace at Edelman Financial Engines in Boston. “This is an emotional process, and it goes beyond when someone should take money out of the 401(k) account,” she says. Managed account services can help pre-retirees map out their expenses in retirement. “For many people, there are a lot of considerations such as medical expenses that they haven’t taken into account,” O’Donnell says. “It can be intimidating at the start, but, for many people, it’s a relief when they’ve put together a plan for their expenses in retirement. We have tools and calculators and guidance, and the ability to talk to our advisers, to help them do that.”

GuidedChoice is another resource with tools and staff to help walk pre-retirees through the numbers and come up with a workable budget, says Sherrie Grabot, founder and CEO of the managed account provider, in San Diego. “We determine what monthly income the participant needs in retirement: That’s the base, the foundation, of the decisionmaking after that,” she says.

Pre-retirees can work with GuidedChoice’s online tools, or talk to a GuidedChoice staff member by phone, about issues such as how their budget outlook would be affected by decisions such as spending less on recreational pursuits or working part time during the early retirement years. “There are different variables they can model to get to a place where they feel comfortable,” Grabot says.

As a participant nears retirement, planning starts becoming more about an income strategy, Pannozzo says. “So people need to start to think in a more detailed way about their expenses, such as their necessary vs. discretionary expenses.” A central part of Fidelity’s decumulation guidance is “retirement sustainability,” she says. “It’s a question of, do you have enough income to cover your expenses in retirement?”

The other core issue for Fidelity is considering what someone’s guaranteed vs. nonguaranteed sources of income will be. “We do believe that a portion of a retiree’s essential monthly expenses should be covered by more predictable income sources, and that could be from Social Security, the person’s pension benefit or a guaranteed-income product,” she says.

After a pre-retiree decides on a retirement budget, a managed account service can help with determining which income sources to tap, and when. Edelman Financial Engines can advise a participant on the optimal timing to start taking Social Security, for example. “Retirement-income planning is most important for those people who need to make the most of what they have,” O’Donnell says. “If someone has a high net worth, planning for retirement will be more about tax issues and estate planning.” For those with far less saved, she says, having enough income to feel confident that they can pay their living expenses is the most important issue.

Once a pre-retiree has a retirement vision, a budget and a clear sense of specific income needs, “then comes the retirement-income solution,” Delaney says. “Then a managed account program can say, ‘Would you like to guarantee a piece of that income?’”

Annuity Integration

In the 2022 Retirement Insights Survey from TIAA, among employees not interested in an in-plan guaranteed lifetime income annuity, cost is the top reason cited. According to TIAA, employers recognize this dynamic, and they often see products’ complexity as a major challenge preventing broader adoption of guaranteed lifetime income solutions. Generally speaking, employees see such products as more pricey, confusing and restrictive than employers do—perceptions that highlight the opportunity for targeted education and communication efforts or for creating interest in solutions embedded in other investments.

Delaney worked closely on a partnership, announced in February, in which Morningstar Investment Management LLC and Hueler Income Solutions LLC linked their services so that participants may incorporate a guaranteed-income product into their Morningstar managed account. If sponsors offering access to Morningstar managed accounts through their plan decide to make annuities available as an option on an out-of-plan basis through Hueler, Morningstar will recommend to an interested participant how much, if any, of that individual’s portfolio to allocate to a lifetime-income product, based on the person’s specific situation. Hueler also provides Morningstar with real-time quotes for institutionally priced annuities. The Morningstar/Hueler offering is slated to go live in July.

“It’s a nice way to offer a bridge between accumulating savings in a plan and the income someone needs in retirement, without a sponsor having to include a retirement-income option on the core menu,” says Daniel Bruns, head of digital advice at Morningstar Investment Management in Chicago.

Of course, some sponsors of plans that utilize Morningstar managed accounts also offer in-plan retirement-income products. “Whether our service will give someone advice on specific retirement-income products comes down to whether any products are available in that person’s plan,” Bruns says. Morningstar will give individualized advice on such products in a plan.

Some managed account providers will offer educational guidance on retirement-income products, but will not offer individualized advice. If participants in an Edelman Financial Engines managed account want to buy an annuity, O’Donnell says, “we would be giving guidance and telling them what they should be looking for in [one of these] products, but we would not recommend specific annuities.”

Whether Fidelity’s managed account service will give guidance on retirement-income products “will depend very much on what is available within an employer’s plan,” Pannozzo says. “Some offer an in-plan annuity, and many do not.” Fidelity’s managed account service does not give individualized advice on specific annuities.

Whether a plan offers an in-plan annuity product or not, GuidedChoice can model different options for how participants could utilize an annuity, Grabot says. “They can choose the percentage of their account that they want to annuitize, and then we model what that will mean in monthly guaranteed income,” she says. “A managed account service has to be able to model what participants will get in monthly income if they choose to buy an annuity and what that cost would be for the participant. You have to help them through it, because annuities are complex.”

The Outlook

Personalization comes at a cost, and OneDigital’s Esselman points to the extra expense as the main reason that sponsors utilize managed accounts far less often than target-date funds as the default investment for automatic enrollment. “But the price of managed accounts continues to come down, and we’re seeing their ability to customize advice increase,” he says.

Today’s managed account products are about 70% of the way there to addressing a participant’s decumulation needs, Esselman says. “We’ve still got another 30% to go.” That will come, he says, from improved technology that will allow managed account services to get more granular with individualized recommendations. He points to possibilities such as advice on specific retirement-income products, as well as guidance about specific planning issues—e.g., how much a retiring participant can afford to spend on nonessential items such as travel.

Within a decade, Esselman foresees technology being able to offer individualized guidance that closely resembles what a participant receives in a one-on-one adviser meeting, for a significantly lower fee than managed accounts currently charge.

What role will a retirement plan adviser play in that scenario? “Plan sponsors will always need someone to do the due diligence on the recommendations and advice to participants that a managed account service is actually giving,” Esselman says. “Advisers will still have to go in and drill down, to understand the modeling behind the recommendations a managed account service makes.”

Overall, 24.6% of plans offer a professionally managed account service to participants, according to the 2021 PLANSPONSOR Defined Contribution Plan Benchmarking Report. Just 3.4% of plans surveyed utilize managed accounts as their plan’s default investment for automatic enrollment, compared with 75.6% utilizing target-date funds.

Plan sponsors have many things to think about when considering managed accounts as a default investment, Bruns says. “Fees are certainly a consideration, but it’s also an issue of the value participants receive for the fees, such as helping [those individuals] with the transition to their decumulation phase,” he says.

“A sponsor needs to look at the demographics of that plan,” he continues. “Some plans have very similar employee demographics and planning needs: Everybody is about the same age and has about the same tenure, same pay and same savings rate. Other plans have employee demographics that vary a lot. Professional services firms have employees with very diverse backgrounds and planning needs, for example—that is where managed accounts can make a great deal of sense.”

Art by Andrea D’Aquino