Many surveys have shown Americans’ interest in solutions that help them create a pension-like income stream from their retirement savings. These options, coupled with plan design and education that focus on retirement plan outcomes, have led the industry to an increased focus on income instead of just account balances. This is called the “DB-ification” of defined contribution plans, and while there has been much interest and discussion in the topic, it has not yet fully manifested itself as a trend across the industry.
PLANADVISER recently discussed this interest in retirement income and the complexity that such drawdown discussions bring to the industry with a group of experts including: Robert Merton, Nobel Laureate, distinguished professor of finance at the MIT Sloan School of Management and professor emeritus at Harvard University; Edward Moslander, senior managing director and head of TIAA’s institutional relationship management organization; Timothy Pitney, TIAA’s senior director and institutional investment strategist and Michael Lane, head of the Target Income Group at Dimensional Fund Advisors.
PA: Why are we seeing a trend toward income as the goal with the retirement plan process?
Merton: First, I think we underestimated what happened over the last decade, in the U.S. and elsewhere—the transition from defined benefit [DB] being the core employer retirement plan to defined contribution [DC]. DC was created primarily as a supplement to DB plans—along with Social Security. These plans were originally designed for higher-earners, whom employers expected to be able to take care of themselves in retirement. DC was envisioned as something closer to a savings plan, providing liquidity at retirement when people had a strong baseline income though their DB plan and Social Security.
Now that DC has become the core retirement savings vehicle, and not a supplement, it’s very different—particularly for working, middle-class people. As with DB plans, we have to be more focused on the benefit for participants.
A second key driver is the demographics of our society. In the U.S., approximately 77 million Baby Boomers will retire over the next 15 to 18 years. DC providers have started to realize this group will want benefits. We always knew retirement was a two-act play, accumulation and payout, but when the Boomers were in their 30s, 40s and 50s, the focus wasn’t on drawdowns. Now it is.
Third, participants are now responsible for making investment decisions about their retirement plans. That’s something they didn’t have to do with a DB plan, and they may not know how to do in the present nor be able to figure it out in the future. We have to find ways to help them make responsible decisions with respect to replacing their working income in retirement.
The endpoint to achieve a good retirement is income—and that should influence what individuals do with their money 20 or 30 years before. It can’t be about wealth accumulation and then magically switch at some age to being about income.
PA: Tim, why else is it important to have this conversation today?
Pitney: Putting relatively complex investment decisions in the hands of participants who generally have no financial experience is problematic. That’s been especially evident over the last 15 years, because we’ve had severe downturns in the market during 2000, 2003 and 2008.
Sustained, historic declining low-interest-rate environments have made it difficult to produce income through the capital markets. From 1982 to 2000, we had 18 years of a bull run; we had one down year in the market in 1991, it wasn’t too hard to pick a winner. But now it seems much more difficult. We think people want more guided solutions and more security when looking for retirement income.
Another reason we should be having deeper conversations about income, from day one when someone enters a DC program, is to overcome the recent shortcomings of solutions being used in the market. The other major trend is the growth in target-date portfolios and lifecycle investments in response to the Pension Protection Act [PPA] and the safe harbor provisions. While they may have done pretty well at accumulation, income has generally been ignored. Consultants, plan sponsors, participants and most practitioners would agree that income should be the primary goal of any good DC plan, yet we’ve seen a huge shift in assets to target-date funds, which don’t provide for any type of guaranteed sustainable income and don’t manage the risks associated with retirement income.
And we also see signs the regulators share our concerns. For example, in 2013, the DOL [Department of Labor] published tips on evaluating these funds reflecting their concern about how target-date funds were being managed and the perception among participants and plan sponsors of what target-date funds were set to accomplish. Curiously, it suggested a custom approach might work better because it could be tailored to better fit plan demographics and a plan’s ultimate goal.
“DC was envisioned as something closer to a savings plan, providing liquidity at retirement when people had a strong baseline income though their DB plan and Social Security.” —Robert Merton
In 2014, the DOL issued regulatory notices, allowing deferred income annuities in target-date funds and letting them qualify as the QDIA [qualified default investment alternative]. The Department issued a notice on QLACs [qualified longevity annuity contracts] to provide additional income in retirement, and in 2015, it clarified annuity safe harbors. So, I think they would agree that expecting participants to draw down accumulated assets, providing a sustainable income in retirement, is difficult to do.
Finally, we’ve seen a confluence of 403(b) plans and 401(k) plans since the 403(b) regulations in 2009. We believe the goal of 403(b) has always been to deliver sustainable lifetime income in retirement. 403(b)s have learned much from 401(k)s over the last five to 10 years, on governance, fiduciary practices, menu design, etc. But the 401(k) industry has much to learn about providing sustainable income using solutions that target income replacement.
PA: How is the industry responding to this focus on income?
Lane: The industry is focusing on income replacement calculators that show what participants’ accumulated savings may provide in today’s income terms. I believe that’s a good first step. And, from the industry perspective, I see many improvements where account values are starting to be reported in income terms.
However, I haven’t seen where many providers are incorporating many of the best features of DB plans into a DC plan, not just reporting expected income but actually managing the risk and volatility of that income number.