Interest in annuities among the defined contribution plan community is on the rise. In this piece, I summarize some of the key points in a paper recently published through the Retirement Income Institute of the Alliance for Lifetime Income, which explores key considerations for plan sponsors who are deciding whether to include an annuity in a DC plan.
Five annuity product-types were considered in the research: single premium immediate annuities (SPIAs), deferred income annuities (DIAs), a fixed annuity (FA) with a guaranteed lifetime withdrawal benefit (GLWB), a variable annuity (VA) with a guaranteed lifetime withdrawal benefit (GLWB), and protected lifetime income benefit (PLIB) strategies, in addition to delayed claiming of Social Security benefits.
Overall, I find that the notably different product (and benefit) structures and varied preferences among plan sponsors make it unlikely that there is (or will be) a single product or strategy that is truly optimal for all DC plans. However, there can be significant benefits to participants who have access to institutionally priced, high-quality annuities. Therefore, plan sponsors should actively explore the space and consider strategies that work best given their objectives for the DC plan and their participants.
Defining “Optimal”
Research on annuitization has largely focused on the economic benefits of a given strategy (e.g., should the retiree annuitize), which ignores the general preferences of retirees and the actual product landscape. In reality, there are a variety of domains that could affect the definition of a truly “optimal” annuity, such as behavioral considerations, the product landscape, and economic efficiency.
It is unlikely a single product could be considered optimal across all three domains. For example, while DIAs are often described as the most economically efficient annuity (especially by retirement academics), there are a significant number of product and behavioral considerations that should be considered before selecting the product for a plan.
For example, research I recently conducted with Branislav Nikolic demonstrates the relatively extreme variations in DIAs over time, especially among those with pronounced delay periods (e.g., 20 years).
These considerations are interconnected. Making a product more behaviorally attractive could actually increase the economic efficiency if it induces individuals who otherwise would not buy an annuity to do so. Products with GLWBs have annuitants who are notably less healthy (i.e., have higher mortality experience) than those who have purchased DIAs, which is going to affect the pricing of respective annuities.
While defaulting participants in a DC plan into any form of an annuity has the potential to reduce adverse selection effects, the decision to actually annuitize (i.e., turn the monies into income) is typically up to the participant in many structures. Therefore, while adverse selection effects may be reduced by including an annuity as part of the default investment, they nevertheless remain, which has important implications on pricing (or relative value).
The following exhibit summarizes some of the key differences between the various annuitization options available to plan sponsors across these three dimensions for the five annuities considered, in addition to delayed claiming of Social Security benefits.
Attractiveness Across Dimensions, Specific Factors
The grades in the above exhibit are somewhat subjective and are based on the current pricing environment (which could obviously change). For example, SPIAs and DIAs are graded as relatively attractive from a cost transparency perspective versus a VA+GLWB which receives the lowest score. This is based on the simplicity associated with determining the quality of the expected income benefits. With a SPIA the payout rates from the providers can easily be compared. Alternatively, payout rates from a VA+GLWB are only one part of the product, which need to be assessed in their entirety.
Regardless, while some strategies are likely to be better for retirees, on average (e.g., delayed claiming of Social Security retirement benefits), it is unlikely there could ever be one single strategy that is truly the best for every plan or participant out there.
Conclusions
While DC plan sponsors are increasingly focused on keeping participants in the plan post-retirement, there are a variety of perspectives on what it takes to make a Defined Contribution plan retirement friendly.
Annuities or other products that provide protected income are under increasing consideration by plan sponsors as one way to simplify the process for generating income in retirement for participants, while explicitly protecting retirees from longevity risk.
While it is unlikely that there will be a single product or strategy that is going to work for all DC plans, actively considering annuities and understanding the landscape is an important first step for plan sponsors interested in helping participants achieve a more successful retirement.
SEE ALSO:
• Guaranteed Lifetime Income Solutions May Grow Retirement Spending Power
• With ‘Peak 65’ Nearing, More Advisors Consider Annuities
These materials are for financial professional use only and should not be further distributed by the recipient.
Receipt of these materials by anyone other than the intended recipient does not establish a relationship between such person and PGIM DC Solutions LLC (“PGIM DC Solutions”) or any of its affiliates. These materials are not intended as an offer or solicitation with respect to the purchase or sale of any security. The information presented is not intended as investment advice and is not a recommendation about managing or investing retirement savings. These materials do not take into account individual investment objectives or financial situations.
David Blanchett, PhD, CFA, CFP, is Managing Director and Head of Retirement Research, DC Solutions for PGIM, the global investment management business of Prudential Financial, Inc. In this role, he develops research and innovative solutions to help improve retirement outcomes for investors. He is also an Adjunct Professor of Wealth Management at The American College of Financial Services and a Research Fellow at the Alliance for Lifetime Income.
