Jones: The issue of a “guarantee,” offered through insurance, speaks to the idea of longevity protection—not outliving your money. Certainly annuities are a very important element in addressing longevity risk, but that doesn’t necessarily mean they need to be inside the plan. We’ve developed a service, Income+, that is a component of our professional management or managed accounts; it provides sustainable lifetime income but allows for an annuity purchase to occur outside the plan. It doesn’t require the plan sponsor to put insurance products into its plan, but still provides the option of a sustainable lifetime income stream. The reason that’s important to sponsors is there are a number of fiduciary ramifications to bringing insurance products into a plan.
Notably, it does one other thing, which is that it does not force the decision of when to annuitize to happen at retirement. In our research with participants, we found that very few people are comfortable annuitizing at retirement. The reason for this is a very strong behavior bias that people have to avoid making irrevocable decisions early in retirement.
If you talk to people later in retirement, when they’re in their late 60s or early 70s and have had a number of years to get acclimated, they are much more likely to be able to make that decision and to see the benefits of longevity protection. It turns out the economics of annuities are such that it’s actually not necessarily a bad decision to “self-insure” in those early years and only purchase insurance later when it really counts. If fact, it can be significantly cheaper to self-insure in the early years of retirement.
PA: What percent of a participant’s portfolio should be divided to lifetime income?
Jones: It depends on each individual’s circumstances. The reality is not every participant should have more annuity income. Some people have plenty of annuity income in the form of a defined benefit (DB) plan and Social Security.
If you have a household that needs more annuity income, or that would benefit from having more longevity protection and more retirement wealth in the form of an annuity, by far the cheapest way to do that right now is to “buy” more Social Security benefit from the federal government.
Individuals can defer the start date of Social Security benefits and thereby significantly increase the lifetime benefits they’ll receive from Social Security. So, every dollar that you “invest” to defer your Social Security start date, the government is offering you 6% to 8% higher payments for the rest of your life, indexed for inflation, backed by the full faith and credit of the federal government. That is a really compelling deal and much, much better than you will find in private insurance markets right now.
So, the number one thing that participants should be doing is asking themselves: “Are we getting the most Social Security benefits that we could be getting?” Once you’ve exhausted that, then you can talk about whether it would be appropriate to buy further annuitization through private insurance markets.
PA: Do you educate people about the value of delaying Social Security benefits?
Jones: Yes, we do. Most people don’t understand the opportunity that exists with Social Security. For individuals, the potential gain in lifetime Social Security benefits can be on the order of $100,000, and for a married couple it’s about a quarter of a million dollars. We’re talking about numbers that are multiples of what many participants had actually saved in a defined contribution (DC) context.
We think this is a crucial issue for Baby Boomers to understand, because this is the first generation that is retiring with any significant amount of money in a defined contribution plan. They don’t know how to create income from the plan and match that up with perhaps a DB plan or Social Security or other sources of retirement income. Putting those pieces together is one of the areas where we can add the most value.
Heard at PLANADVISER National Conference
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 plan sponsors may need to address is how to unwind a specific income product or bring it outside the plan in order to pursue a better choice.
Fiduciary lock-in is a core issue, leading some plan sponsors to reject these products, Jones said. The issue of a guarantee does answer longevity protection, and certainly annuities are an important piece in reaching a solution, he added. But this does not necessarily mean the product must be in the plan.
For one possibility, some managed accounts allow for an annuity purchase to take place outside the plan; this enables the plan sponsor to offer access to a stable income stream, yet avoid having to add insurance to the plan—a solution that may appeal to both participant and plan sponsor. A key difference, according to Jones, is that this solution requires no decision as to when to annuitize. “Very few people are comfortable annuitizing,” he said, citing behavioral reasons and safety concerns. “People are unwilling to translate an account balance into an income stream.” Later, after acclimatizing to retirement, perhaps in their 70s, they are much more likely to see the benefit of longevity protection, he said.Advisory services provided by Financial Engines Advisory L.L.C., a registered investment advisor and wholly owned subsidiary of Financial Engines Inc. Social Security decisions are highly personal and depend on a number of different factors. Financial Engines does not guarantee future results.