Retirement Plans – The Gift that Keeps Giving
Defined contribution retirement plans have always prioritized their participants’ retirement security in their plan designs. They now realize that the savings or accumulation phase is only one element of the mission. Income solutions that provide a paycheck-like experience in retirement are required too.
Participants want lifetime income
More employees want to stay in their plans after retirement. The employer is a source they trust. Plans also want them to stay for a host of reasons — including the belief that in-plan solutions will better serve participants. If employers want to retain people in the plan, they must also offer solutions for the postretirement phase of life.
Participants face many spending dilemmas in retirement: overspending, financial uncertainty due to market volatility, inflation and the longevity risk of outliving their money. One reason participants overspend is that they have no idea how to create a sustainable withdrawal rate for drawing down their nest egg, which should probably be far lower than most people currently assume.
Plans can help. DC retirement plans need to start by shifting their focus to the individual, not the average participant. A holistic framework needs to account for the impact of all types of potential risks — mortality, longevity, liquidity and inflation.
Default options
Sponsors (that set up and oversee retirement plans) need to complement the flexibility of existing structures with the ability to provide guaranteed income. They seek solutions that are:
- Simple.
- Flexible, to meet the needs of different types of participants.
- Transparent in terms of costs.
- Operationally feasible.
To impact a broad percentage of their population, lifetime income solutions must be part of the default option. That is where participants are automatically slotted unless they opt out. These one-size-fits-all defaults are still overly generalized. They should also offer flexibility in the guaranteed income level, the retirement date and the date the participant will begin to secure income.
The industry has put in place fixes to shore up a number of shortcomings. For instance, defaults, auto-escalation and target-date funds address poor participation, contributions and investment diversification. (An auto-escalation allows plan participants to regularly increase their contributions until they reach a preset level. Target-date funds periodically rebalance asset classes, inching toward a more conservative mix.) The time has now come to fix the retirement income side as has been accomplished for accumulation.
In that context, any investment used as a default still needs to provide liquidity, even if a portion is allocated to guaranteed lifetime income. You can’t default someone into something that requires them to make an irrevocable decision. Most participants don’t want to become portfolio managers, especially in something as complex as providing income for life. They want income for life, regardless of the market environment and how long they live.
Factors driving success
Plans and employers should understand participants’ other income sources, calculating the income replacement rates provided by Social Security or perhaps a defined benefit plan. Make the retirement income solution complementary to these other income sources. A plan’s demographics matter. For instance, a relatively low-earning participant population may find that Social Security alone could provide sufficient income replacement, reducing the need for a dedicated retirement income solution.
Develop appropriate educational messaging for those nearing or in retirement. When you introduce retirement income, rely on communications to address features that participants haven’t previously encountered.
Increasingly, the line between working and retirement will blend. The implications for structuring retirement income include the need for flexibility and liquidity while still providing longevity protection. Retirement income should help participants meet their spending needs through a phased or full retirement while ensuring against the risk of outliving their savings.
An overarching message for plans is to keep it simple. Many people don’t know how to spend in retirement — it is something they need guidance with. Participants are looking for flexibility, with a preference for a total-return strategy that offers options for guaranteed income.
Talk to your financial advisers about how to structure a retirement plan that offers your retirees long-term income security.
©2023
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