There has been a recent upsurge in interest around extending the capabilities of defined contribution plans to better prepare plan participants for a secure and healthy retirement.
Traditionally, such plans were viewed as accumulation vehicles, with funds often rolling over to retail investment vehicles at retirement or employment separation. This model is now being reconsidered as it becomes clear that America’s retirement readiness could be substantially enhanced.
It’s potentially achieved by leveraging the combination of the 401k’s purchasing power relative to that of the retail consumer in this cost-conscious environment, combined with heightened product innovation that is expanding the universe of in-plan possibilities.
While substantial changes certainly seem to be on the horizon, plan sponsor implementation of new decumulation strategies remains in the early innings of what, based on the demographics of the Boomer population, is certain to be a many-year game.
The advisors/consultants with whom we have spoken are relied upon by sponsors to introduce and educate them around new DC innovations. Unfortunately, by its own admission, the advisor community remains largely unaware of new product developments as regards in-plan decumulation options.
A recent paper by the Institutional Retirement Council (IRIC) seeks to quantify in real dollar terms the potential financial ramifications for plan participants of in-plan institutional pricing, as well as guaranteed income options.
It should come as no surprise that 401k plans benefit from lower investment and distribution costs vis-à-vis retail, given their institutional bargaining power. Once plan participant assets are transferred to retail vehicles (such as IRAs or annuities) costs can and often do rise dramatically to cover the issuer’s payment of commissions, as well as higher asset management fees and administrative costs, etc.
The IRIC paper examined three different scenarios which underscore the additional income and end savings a plan participant can garner by keeping assets in the plan and taking advantage of these lower costs.
Scenario No. 1: Lower costs and traditional systematic withdrawal (non-guaranteed)
In scenario No. 1, the IRIC examines the salutary impact to retirement income/end savings when considering a 20, 40, and 60 basis point cost savings for systematic, non-guaranteed withdrawals taken in-plan versus out-of-plan.
In detailed charts found in the appendix, the paper observes that additional income and terminal savings range anywhere between $268,000 to $798,000 at age 95—again, all driven by the lower in-plan cost structure.
Scenarios No. 2 and 3: Lower costs combined with guaranteed income
While the savings in scenario No. 1 are notable, they become more attractive when comparing the returns of some in-plan guaranteed income options, of which there are a growing number available in the market via variable and fixed annuities.
For instance, the paper examines a second scenario in which a plan participant invests in an in-plan variable annuity with guaranteed minimum withdrawal benefits (GMWB). This is compared to similar income drawn from the same variable annuity acquired out-of-plan.
Again, with relatively conservative assumptions clearly detailed, the total lifetime income and end market value at age 95 equates to $832,000 of additional income/savings with the in-plan option.
In the final scenario, the paper compares the additional income and savings from acquiring a deferred fixed or immediate fixed annuity in-plan versus in the retail market. In this case, IRIC estimates that a plan participant could earn a fixed rate of 25 to 50 basis points higher by adopting the in-plan solution which, in turn, would yield between $82,000 to $164,000 of additional income at age 95.
Conclusion
While not all of these changes in the retirement plan marketplace relate to in-plan income solutions, the ability of defined contribution plans to provide more attractive income and ultimate savings to plan participants, on a risk-adjusted basis, is becoming more apparent.
By all appearances, the federal government is reaching a similar conclusion, passing legislation – such as the SECURE Act – that has hastened innovation within 401k plans. At the same time, federal rules around the fiduciary responsibility of advisors who recommend rollovers have been strengthened in an effort to disincentivize recommendations that may benefit the advisor without commensurate benefit to the advised.
The combination of burgeoning income options within 401k plans, together with closer scrutiny of the traditional roll-over model, seems to indicate that change is already afoot in our industry, with mainstream awareness sure to follow.
About the authors
Michelle Richter is the executive director of The Institutional Retirement Income Council, a non-profit, membership-based organization of institutional retirement plan advisors.
David Paul is a principal at ALIRT Insurance Research, a firm specializing in the financial oversight of insurance companies.