Retirement Income Options

When 401(k) plans got their start in the American workplace, they were typically intended as vehicles for individuals to save in, over and above contributions made on their behalf to a company’s defined benefit (DB) pension plan. They have evolved considerably in the nearly 40 years since then, to become a primary source of retirement income—well-designed machines that convert employees to participants and invest their savings efficiently, economically and, in many cases, more or less automatically.

But today, the U.S. work force is retiring in growing numbers, and sophisticated mechanisms to complete the cycle—i.e. turning those hard-won assets into a systematic, long-lasting DB-style retirement income—are conspicuously absent from many plans.

“The accumulation phase is more easily addressed through single solutions, but retirement income is a different ball game, as every retiree has different objectives to be met,” notes Lorie Latham, senior defined contribution (DC) strategist at T. Rowe Price Group in Baltimore. “As an industry, we have swiftly moved to handle the problem with products, but I think that completely misses the mark,” she adds. “It falls to the plan sponsor community and its advisers to understand how to meet those objectives.”

For the individual, saving and investing for retirement is plenty challenging, requiring the sacrifice of current income and consumption, and sticking to that ground plan over many years. But it is pretty straightforward, especially with professionally managed vehicles such as target-date funds (TDFs) designed to maximize risk-adjusted returns at a reasonable cost and relieve participants of the heavy lifting of selecting investments.

Not so for spending in retirement, however: Retirees face competing priorities, and this makes for complicated, far-reaching decisions. “Preparing for living in retirement is far more complex than what the defined contribution industry has focused on for 30 years,” says David Gray, senior vice president at Fidelity Investments in Boston. “It’s so personal, and it isn’t just about the retirement plan but about what people are going to do with themselves every day, where they are going to live, and when they will start drawing on Social Security.”

“Given the differences in family and health care situations, two people who might have the same amount saved at retirement could be in very different positions, in terms of financial security,” echoes Patrick Murphy, president of John Hancock Retirement Plan Services, also in Boston.

“Employees trust their employers, which puts [the latter] in the ideal situation to give unbiased and skilled guidance, whether on their own or with the help of advisers,” says Steve Vernon, a retired pension consultant and actuary, now a consulting research scholar at the Stanford Center on Longevity. “We’re all aware of the power of defaults, so sponsors should put themselves in the shoes of an older worker wondering whether he has enough to retire on. Absent any other information, the default response may be to keep working, and employers may wind up with a work force management issue—a growing cohort of older workers hanging on and on.”

Sponsors understand the underlying need but are lagging. “In mainstream corporate America, there is a lot of hand-wringing about retirement income for DC participants, but foot-dragging when doing anything about it,” observes Martha Tejera, head of plan consulting firm Tejera & Associates and a board member of the Institutional Retirement Income Council, speaking to PLANADVISER from her winter headquarters in Tucson, Arizona.

In the 2017 PLANSPONSOR Defined Contribution Survey, 57% of plan sponsors reported offering no retirement income products to participants at all, while just 20% said they provided some sort of product or access, whether in or out of their plans.

Rather than rush to offer products, advisers might take a step back to consider sponsors’ goals. One crucial issue is whether a sponsor’s wish is to keep participants and their assets in the plan after they retire. “There’s a big shift in thinking, from wanting people to leave the plan when they retire, to doing what’s best for them as employees and then post-termination,” Tejera says.

“There’s a strong trend toward having a line of sight for keeping assets in plans,” Latham notes. “There are many reasons, but after the fiduciary rule, the controversy about conflicts of interest raised the bar. Sponsors said, ‘It gives us scale and buying power; it keeps participants in a narrow and vetted investment solution set that we monitor on their behalf, and there is a lower cost profile.’”

If there is a desire to keep retirees on, advisers should ensure that plans are flexible as to money flow. “For instance, there are plans that allow participants to leave their money invested but don’t permit partial distributions,” Tejera says. In such cases, sponsors should instruct the recordkeeper to  pay the participant in quarterly amounts he has specified. Next, she counsels, retiring employees should be enabled to roll assets into the plan from other individual retirement accounts (IRAs) or 401(k)s.

Advisers can also help sponsors better understand the demographics and motivations of their participants. “We see plans where 50% of the participants are retirees, but the conversation in the board meetings is about investments for accumulation rather than retirement,” Murphy says.

With a fresh affirmation of plan goals, advisers can suggest approaches for generating retirement income. To sponsors’ credit, many have offered some sort of planning: About 75% of those responding to a 2016 Willis Towers Watson survey provided retirement planning tools or education, or expected to add them within a year.

Based on her experience with investor focus groups, Latham has found that the preferred form of advice varies by age cohort. “[Baby] Boomers want someone to sit down with. Millennials lean toward robo-advisers, and Gen[eration] X is somewhere in between. The adviser community is going to have to be nimble with a solution orientation and not just a product,” she says.

But there is a role for investment products that systematically distribute income, and it brings yet another complicated decision. One route is to offer structured payout strategies; some target an annual return, while others spend down assets over a defined time frame. Household-name asset managers have brought a few such products to market in the last 10 years, but so far they have gained little traction, and some have been withdrawn or reformulated. “The idea is often to move all of a retiree’s money into one fund, but these are new, and, with only short track records and such an uncertain fixed-income environment, I can understand investors’ hesitation,” says Leo Atcheson, a senior analyst of multi-asset funds at Morningstar in Chicago.

In addition to investment accounts meting out structured payouts, Tejera says she is an advocate of fixed annuities, particularly for retirees with lower balances. “That view shows my bias as an actuary, but participants draw the most income for the least amount of investment, and payments are guaranteed by an insurer.”

Art by Sam Berenfield