When it comes to new lifetime income-developments in defined contribution (DC) plans, the usual tendency is to track what the largest corporate 401(k) plans are doing. Although 403(b) plans don’t seem to garner as much attention, they’re still an enormous market. According to Plan Sponsor, over 17 million participants had invested about $1 trillion in 403(b) plans as of year-end 2018.
One reason for the different perspective on 403(b) plans is their historical development. From 1958 through 1974, plan participants were restricted to investing in annuities. That constraint was removed in 1974 and plans could add mutual funds to their lineups. While 401(k) plans recently opened up to private equity investments, though, 403(b)’s are still restricted to annuities and mutual funds, hence the latter’s stodgier reputation.
That doesn’t mean the market lacks advances, though. Yale University’s recent DC plan redesign highlights some of the lifetime-income innovation occurring in the 403(b) market. The school has multiple plans with about 15,000 active participants, 12,000 retirees and total assets of roughly $6.7 billion spread over four DC plans.
In late 2016, the school began working with investment and retirement plan consultants Aon to revamp their plans’ default investment option. Although Aon was initially engaged to evaluate the default option, including prospective target-date funds, the engagement evolved, according to Bill Ryan, a partner with Aon. “Yale was very open toward finding what they thought was the best solution, not what was the most common solution,” Ryan explains. “We started to explore different avenues that were available to them and their service providers.”
The school had a long-term relationship with TIAA, which served as the plans’ recordkeeper and sole provider of its annuity accounts. That relationship was important in the plans’ redesign for two reasons. First, many 403(b) plans accept multiple annuity providers; having one provider simplified the redesign. The second reason was that TIAA had been developing an open-architecture technology, RetirePlus® Pro, which provided a managed account infrastructure to support a customized qualified default investment alternative (QDIA).
The general thinking around DC plans has been shifting from savings balances to retirement income and that paradigm influenced the resulting plan design. “Yale early on was very clear that this was a retirement plan, not a savings plan,” Ryan emphasizes. “They said that from day one, we are building a retirement plan of the future.”
The redesign was complicated by the presence of multiple retirement plans for different employee populations at the school. One group was union members that still had access to a defined benefit plan. Staff and faculty did not have a defined benefit plan. The third group were those employees who were not eligible for Social Security. “So they had very distinct populations that were very for lack of a better word, cleanly separated, so that we could actually build a solution for the demographic of that employee type,” says Ryan.
Aon developed asset allocation models and portfolios behind the scenes and ported them into TIAA’s technology. After extensive consultations with Aon and TIAA, the school decided on a pared down QDIA that included mutual funds from Vanguard plus a fixed-annuity account from TIAA. The lineup did not include any bond funds, however, instead using a group guaranteed annuity for the fixed income allocation.
Both firms collaborated on the current version of the risk tolerance questionnaire that the participants can complete to fine tune the initial recommended portfolio. “TIAA will show a participant the default or the portfolio that we recommended based on the information that TIAA had, which is basically age and which of the three retirement plans they were in,” says Ryan. “And the more the participant engages in a five- or seven-questions risk tolerance questionnaire, we would get an alternative outcome, or it may say you're in exactly where you're supposed to be, or consider option B.” After an extensive program to educate participants, the revamped plan debuted with a March 2019 re-enrollment; over 90% of participants re-enrolled in the QDIA.
Another feature of the program is that participants approaching retirement can speak with a TIAA representative to determine how much, if any, of their balance they might annuitize for a guaranteed income. Total annuitization is not required, Ryan explains--partial or staggered annuitization is permitted. One goal of the sessions is to replicate what used to be the common experience of meeting with human resources to discuss pension options. “A participant can retire in a way that feels very similar to the environment in which you'd go into a benefits office and activate your defined benefit plan,” he says. “You meet with a counselor, they would tell you what your benefits were and you choose how you want to structure that income stream.”
The revamped program is in its second year so any shift in participants’ thinking from plan balances to retirement income isn’t measurable yet. But the feedback from participants has been encouraging, says Ryan: “Some of the common feedback we heard from the town halls, or at least what was conveyed back to Yale was people were saying, thank you for making retirement simpler for them by making the decision on how to invest simpler.”