Prudential’s Srinivas Reddy, senior vice president for full service investments, and John Kalamarides, senior vice president for institutional investment services, penned the white paper, “Guaranteed Lifetime Income and the Importance of Plan Design,” which was shared with PLANADVISER prior to publication.
The research suggests plan design—most notably the makeup of a plan’s qualified default investment alternative (QDIA), along with the adoption of automatic enrollment and deferral escalation—play a pivotal role in unlocking the full potential of lifetime income solutions. Reddy and Kalamarides suggest the time is right to build a smarter QDIA that begins the process of building a lifetime income stream from the first day of participation in the retirement plan.
To test this premise, the white paper looks at real participant outcomes based on plans’ decisions to utilize a QDIA that includes a guaranteed lifetime income portion. The study tracked more than 1,900 defined contribution plans served by Prudential and more than 2 million participants between December 2008 and December 2013, Reddy tells PLANADVISER. It centered on the impact that Prudential IncomeFlex has had on participant behaviors and outcomes.
As explained by the white paper, IncomeFlex is a guaranteed lifetime retirement income benefit that can be combined with a wide range of underlying investment programs, including target-date funds, interactive asset allocation programs, custom balanced portfolios and managed accounts. While Prudential had already been offering the product for use in QDIAs, the solution received an additional nod of approval from regulators in late October when The Department of the Treasury and the Internal Revenue Service issued guidance designed to expand the use of income annuities in 401(k) plans.
“In short, our research found that starting participants with a lifetime income investment supports and improves the benefits generated by automatic enrollment, automatic contribution escalation and other prominent plan design features,” Reddy says.
Notably, the paper shows plans in Prudential’s book of business with automatic enrollment and a default investment option that includes IncomeFlex have an average participation rate (87%) that is substantially higher than plans without IncomeFlex or automatic enrollment provisions (65%). Plans with only IncomeFlex but lacking auto-enrollment do somewhat better, at 72% participation, Reddy notes.
“When workers are left to their own devices in a plan without a guaranteed income benefit, participation rate is a relatively disappointing 65%,” Reddy explains. “While adding IncomeFlex to a plan’s investment lineup improves that participation outcome, the highest rate is achieved by combining IncomeFlex within a default investment that is coupled to automatic enrollment.”
While some in the marketplace have concerns that adding in-plan guaranteed income (which typically involves tying up account dollars for long periods of time) could increase opt-out rates, Reddy says the Prudential paper actually shows the reverse is true—as plans with IncomeFlex show a nearly 3% reduction in opt-outs over those without in-plan income.
The white paper also examines the impact lifetime income offerings have on “non-automatic enrollment participants,” or those who were not defaulted into a plan’s QDIA. As with defaulted investors, Reddy says there appears to be a positive impact on plan-related decisionmaking when lifetime income is made available.
“For example, plans without IncomeFlex or automatic enrollment had 7.8% average salary deferrals, while those with IncomeFlex had 8.3% average deferrals,” Reddy explains.
When combined with automatic contribution escalation, the impact is even greater, Reddy adds. Between 2010 and 2013, participants in plans with IncomeFlex but without auto-escalation saw their average contribution rate grow from 4.6% to 6.7%, for 46% growth. At the same time, participants in plans with auto-escalation and a QDIA with IncomeFlex saw their average contribution rate grow from 4.4% to 7.0%, for a 59% growth.
“These findings are good news for plan sponsors and participants in light of the fact that nearly half of DC plan sponsors have noted ‘increasing participants’ savings rates’ as the number one or two priority on their list,” Reddy says.
The paper concludes by showing intelligent plan design that leverages diversified QDIAs, in-plan lifetime income, and automatic enrollment features can reduce the number of undiversified investors (those with 100% of assets in either stocks or bonds, or heavy concentrations in single securities) by as much as 67%.
Reddy and Kalamarides close the paper with three tips:
- Start participants saving and investing as soon as possible for the purpose of generating future retirement income;
- Start them off with an investment option that delivers appropriate diversification and offers “guardrails” against behaviors that can push them off track; and
- Provide a mechanism to increase participants’ base for guaranteed retirement income as their earnings grow.
“In our opinion, this is the definitive formula for transforming America’s retirement industry for the betterment of all, taking American workers from their day one of employment to their day one of retirement with confidence,” the pair writes.
The paper has been made available for download in full here.