Spring metaphorically means a season of positive change and new opportunity. How appropriate given the changes emerging for plan sponsors as regards to offering retirement income options in their defined-contribution (DC) plans
A recent paper by the Institutional Retirement Income Council tackles the topic of how plan sponsors can best integrate guaranteed income options into DC plans to benefit both plan participants and themselves.
The paper highlights how the three-legged stool of the nation’s current retirement system—consisting of Social Security, employer-sponsored pensions or retirement savings plans, and individual savings—has become increasingly lopsided over the past 20 years with the near demise of the defined-benefit (DB) plan, what most people think of as a traditional pension. In short, the crucial income guarantees once tied to DB plans have been curtailed substantially, placing more responsibility on the individual to make savings and investment decisions that are often beyond a participant’s ability.
In recognition of this trend, and in an attempt to “nudge” plan participants to save more, the Pension Protection Act of 2006 aided employers by introducing automatic enrollment plans. An important element in this legislation was the need to offer a qualified default investment alternative (QDIA) which in most plans consists of a target-date fund (TDF). The success of this legislation is obvious: by 2020, assets in TDF QDIAs had grown to almost $3 trillion from almost nothing 20 years earlier.
Other innovations followed, including the introduction of auto-deferrals and auto-escalation, again in an attempt to apply behavioral tactics to urge plan participants to save and invest more for retirement. The industry is now looking again at regulatory enhancements to promote guaranteed income within a plan’s QDIA. The newest proposal, sometimes dubbed Auto-RISE (Auto Retirement Income Security), would proactively promote the automatic investment of a certain percentage of savings into deferred annuities built into the QDIA structure.
While the positioning of income annuities was addressed in the original QDIA regulations, their use in these plans was further strengthened by regulations and guidance issued in 2014 and 2016. The SECURE Act of 2019, however, gave a boost to annuities by providing fiduciaries and plan sponsors a safe harbor for their use either inside a plan’s QDIA or as a stand-alone option. New proposed legislation, the Lifetime Income for Employees (LIFE) Act, would state that annuities can be offered as a QDIA.
But are 401(k) plans even the place for income solutions? Should 401(k)s play a bigger role than that of being simply a supplementary savings vehicle? As noted in the IRIC paper, there can be benefits for both employers and participants.
Providing income options in a DC plan offers several benefits to the employer, most of which make it possible for a worker to leave their job and retire when they choose to.
For instance, a study by Prudential showed that a one-year rise in average retirement age results in an incremental cost of over $50,000 to the employer, representing the employer’s cost differential between the employee desiring to be already retired and that of a newly hired employee.
In addition, employees who want to retire but are “income insecure” and unable to retire, prevent junior employees from moving up and growing professionally, leading to both the potential loss of current talent as well as difficulty in attracting new hires.
Lastly, through-retirement plan offerings allow an employer to retain more DC assets and lower recordkeeping costs, while the specific inclusion of an income solution—along with other financial wellness tools, such as education—adds to the appeal of the overall benefits plan, helping to attract workers in today’s very tight labor market.
Much has been written about the lack of retirement readiness across a swath of the population. An obvious benefit objective of a DC plan designed to help employees save and invest throughout their working years — and then distribute those accumulated funds in a secure and adequate manner over one’s postwork lifetime — is to provide a secure retirement offering. And the prospect of accessing a secure retirement should result in a productive and motivated workforce, as well as a powerful tool to attract new and diverse talent over time.
Annuity guarantees in QDIAs can also help protect employees from the financial impact of cognitive decline, reducing the opportunities for poor planning decisions as well as falling victim to financial fraud.
Lastly, studies show that including an in-plan annuity default allows participants to become more accepting of market volatility in the non-guaranteed parts of their retirement savings, resulting in potentially higher overall savings, as well as in an ability to maintain stable spending patterns knowing that they will never run out of funds to cover basic needs.
Despite the benefits to employers and employees, several objections to offering retirement income products within DC retirement plans remain. These include perceived fiduciary risk, portability issues, participant demand/adoption, lack of customized solutions, and lack of plan peer adoption.
Each of these objections, however, is being met through the introduction of new laws/regulations laws/regulations (such as the SECURE Act), technical advances (e.g., standardized file feeds and other enhancements by middleware providers), and product innovation. Together, these solutions provide the groundwork for what could be a broad adoption of in-plan income guarantees over the next decade.
Retirement income is a critical part of the benefit plan, and sponsors need to reassert themselves and take command of this issue for their employees. We believe that all the pieces are falling into place for a substantial extension of the role played by DC plans in providing a safe and adequate retirement for the American working public. We now need only the courage to proceed.
Michelle Richter is the executive director of The Institutional Retirement Income Council, a nonprofit membership organization that provides plan sponsors and advisors with information and research on achieving and maintaining financial health in retirement.
David Paul is a principal at ALIRT Insurance Research, a firm specializing in the financial oversight of insurance companies.