Two trends seem to dominate media reports on defined contribution (DC) plans’ efforts to offer participants retirement income. The first trend is that employers have been hesitant to adopt retirement income, but progress, albeit slow progress, is being made. The second trend is product-focused, with financial services firms rolling out new solutions. As I drill down into the new arrivals’ details, however, it becomes apparent the products/solutions being marketed as new are tweaks on existing models rather than breakthroughs. This has me wondering: Have we reached the end of the line for significant, implementable developments in retirement income, at least for the foreseeable future? Or is it time to change our thinking about the challenge?
Extend the Autopilot
In a recent webinar hosted by Georgetown University’s Center for Retirement Initiatives, David C. John, a senior strategic policy advisor with the AARP, outlined three common lifetime income solutions available for defined contribution (DC) plan participants:
- Systematic withdrawal plan
- Managed payout fund
- Laddered bond fund
- Target date fund with a deferred annuity
- Target date fund with a guaranteed minimum withdrawal benefit (GMWB)
- Immediate annuity
Many of the innovations John has been seeing are essentially repackaged existing products modified in an effort to make consumers want products they haven’t wanted in the past. That approach is driven at least partly by inertia: Innovation with untested products is risky, so it’s safer to repackage the status quo. He suggests that a better approach might be to look beyond repackaging to a more flexible yet still largely automated approach for creating retirement income.
Auto-enrollment, auto-escalation and default investments into target date funds or other professionally managed funds help employees save for retirement. There’s a downside to the auto-features, however, John cautions. “If you think about it, the worst possible solution you can have in a DC plan right now is if you're lucky enough to have auto-enrollment from the day you go to work to the day you retire and having everything been automated, then they essentially hand you a check and say, OK, go deal with it,” he says.
A more efficient alternative would be to offer retirees flexible automated retirement income options, John suggests. These options would consist of:
- A pooled managed payout fund;
- A fund from which retirees could withdraw partial lump sums for emergencies or other special purposes; and
- An annuity or qualified longevity annuity contract (QLAC).
“A target date fund has a very different set of parameters and goals than a managed payout fund does,” he explains. “Combine that with a deferred annuity as at least an alternative for an automatic decumulation strategy. It's something that's flexible. As your mindset changes, you can say, this default option doesn't really work for me and I want to do something else. You have that opportunity, unlike what you have by just simply putting a SPIA (single premium immediate annuity) in a target date fund. You have the option to reverse it and move in a different direction.”
Build the Bridge
Steve Vernon, president of Rest-of-Life Communications, a retirement education company, observes that apart from insurance and investment products, the only other way to generate retirement income is Social Security. Vernon agrees that a platform offering annuities, investment drawdowns and an emergency fund is a good approach, but he would add the option of a Social Security bridge payment fund to the mix. The logic is straightforward and he maintains the strategy benefits any pre-retiree with less than $1 million of savings.
Here’s the case: Delaying the start of Social Security’s retirement benefit is a good strategy financially for most workers. Assume a worker retires before her optimal Social Security starting date. With a bridge account she could delay starting Social Security and instead take withdrawals from the bridge account, which would be invested as a no-risk account earmarked for that purpose. That decision would allow her to replace the Social Security income and defer that benefit’s starting date.
Vernon says research shows this approach consistently outperforms buying an annuity. Most of the time it provides more guaranteed income than any other source and even comes close to beating stock market returns but without the market’s risk. “You could take part of your savings and replace the Social Security benefit that you're delaying,” he explains. “If you're retiring at 65 but you think that 70 is the right age to start your Social Security, then you pay yourself a Social Security benefit from your own savings from 65 to 70.”
Pieces Are in Place
Some proposed retirement income solutions like tontines are still in the discussion stage, but both John’s and Vernon’s frameworks use existing financial products that record-keeping platforms can accommodate. Nonetheless, Vernon admits to a lack of “overwhelming acceptance” for his proposal among industry participants. Part of the reluctance with bridge accounts probably stems from the proposal’s lack of profit incentive for financial institutions, which likely would be transferring funds from higher-margin retirement products like mutual funds and annuities to low-margin, self-liquidating savings accounts. That could change if plan sponsors advocated for it, Vernon believes. Still, the paradigm shift will take time and there is no immediate, simple solution in sight, says John: “It's going to be a process. And part of that process is probably going to be moving beyond what we think of at the moment.”