It’s been two decades since the switch from defined benefit to defined contribution plans occurred for most American workers, and the implications are (still) increasingly felt.
Specifically, more retirees and workers are facing the stark realities associated with managing retirement income in the context of uncertain returns, and uncertainty about Social Security’s viability.
To their credit, regulators realize the need to encourage in-retirement income solutions and have acted accordingly.
A few examples include:
- In 2014, the IRS released Notice 2014-66 which outlines circumstances under which target-date funds can restrict participation in designated age-bands to invest in annuities.
- In a coordinated effort with IRS Notice 2014-66, the DOL sent an information letter to Mark Iwry, Deputy Assistant Secretary for Retirement and Health Policy at the Department of Treasury, describing circumstances when unallocated deferred annuity contracts can be used in a qualified default investment alternative (QDIA).
- A GAO report released in August 2015, 401(K) Plans – Clearer Regulations Could Help Plan Sponsors Choose Investments for Participants, cited a need for greater clarity from the DOL regarding use of lifetime income solutions in QDIAs.
- In 2016, the DOL sent an information letter to TIAA providing greater clarity about the use of annuities as default options even when they don’t meet the requirements of a QDIA and expressed support for lifetime income options.
Separate from regulators’ support of in-retirement income solutions, plan sponsor recognition of the need has increased.
One drastic example comes from a comparison of feedback generated from Metlife’s recent studies on plan sponsors’ interest in lifetime income.
In their 2014 study, 9% of plan sponsors agreed that the core purpose of their DC plan was to serve as an income source during retirement. In 2016, that number skyrocketed to 85%.
Some in-retirement income solutions focus on insurance products that guarantee minimum returns.
The most critical aspect in evaluating any of these offerings is the sponsoring firm’s ability to pay. Other solutions rely on investment strategies that balance income generation with capital preservation.
Solution providers vary in their framing of the challenge, and solution design to execute. A presentation I saw from American Funds did a good job categorizing retirement income solutions in the following buckets:
- Systematic withdrawals
- Self-managed
- Advisory service or managed payout
- Deferred Fixed Income Annuity
- Immediate Fixed Income Annuity
- Immediate Variable Income Annuity
- Immediate Inflation-Adjusted Income Annuity
- Guaranteed Minimum Withdrawal Benefit Annuity
The varied and evolving set of in-retirement income solutions require a different set of evaluation metrics than data and tool providers have historically collected and modeled; making it tough for software providers to keep pace.
Leading advisors are evaluating these options but are faced with more manual efforts associated with due diligence than is required for more traditional offerings.
In-retirement examples
A few examples of in-retirement options advisors are considering that have been around for a while include:
- Prudential Retirement Insurance and Annuity Company has offered IncomeFlex Target funds since 2009. These target date funds include a variable annuity component backed by Prudential’s general account that guarantees retirement income.
- First Eagle Investment Management has positioned its Global Income Builder Fund as a retirement income solution. This fund, which has been around since 2012, is targeted at providing wealth preservation and income without requiring investors to ‘lock-in’ to an insurance contract. The fund has provided 4% distributable Income, an annual 2% COLA increase, and 11% increase in invested capital as of December 31, 2018.
- MetLife launched a qualified longevity annuity contract (QLAC) offering in 2015. This solution allows participants to take a plan distribution the lesser of $130,000 or 25% of their qualified account balance into a QLAC {deferred annuity) that typically results in income starting between ages 80-85. Applied in this manner, the QLAC helps address longevity risk, the probability of outliving one’s retirement assets.
The trade-offs made with in-retirement income solutions are certainty vs. liquidity/flexibility as well as optionality vs. cost.
One approach is not necessarily superior to the others, the needs of each plan (or individual investor) relative to features and costs must be considered.
We encourage plan consultants and advisors to consider the appropriateness of in-retirement income solutions for the plans they manage.
Combined with the backdrop of a long bull market, historically low and uncertain direction of future interest rates, we expect DC options that focus on the generation of in-retirement Income to gain shelf-space and market share in 2019.
John Faustino, AIF, is Chief Product and Strategy Officer with Pittsburgh-based Fi360.