As defined contribution plans continue their metamorphosis from a supplemental savings plan to a full replacement of defined benefit plans, only half the journey has been completed or at least mapped out. People are accumulating assets in the 401(k) and 403(b) plans with auto-plan features helping them to save enough to replace a significant portion of their income.
But adventure fans know that more climbers die on the way down from climbing Mount Everest than on the way up. Even if someone reaches the summit and saves enough to retire, creating a sustainable lifetime income can be much more difficult. In a sense, each person is managing a personal pension plan that would be a challenge for even the most experienced actuary.
So, before we make the case for in-plan retirement income, it is critical to first understand and prepare for the daunting obstacles.
Structural Issues
Record-keeping systems are generally not set up to effectively and cost-efficiently provide periodic payments, and adjustments to their systems may be costly and time-consuming. If a plan offers annuities, it may be difficult for the record keeper to transfer annuities from one provider to another. Record keepers’ technology investments for these changes can be large, and plan sponsors not only have to be able to retain assets of separated employees, but also need to be willing to do so.
Most investments offered on DC menus are not designed to provide income. Before The SECURE Act of 2019, plan sponsors were on the hook if an annuity provider defaulted, even if decades later. Annuities have a bad reputation among plan sponsors, investors and advisors due to opaque pricing and a loss of control. However, using an in-plan annuity can pool resources and risk, and may provide lower costs.
Moreover, while auto-features without personalization work well when accumulating assets, participant needs can be very diverse at retirement, so automation may not be as effective for decumulation, which makes embedding annuities into a target date fund less than ideal.
Other questions include:
- Should the investment be guaranteed (which will increase costs)?
- Are TDFs or managed accounts the right vehicle?
- Is it better to provide retirement income outside the DC plan, where options and technology are more flexible than in-plan?
Drive for Solutions
The need for guaranteed income in retirement by DC plans and participants is overwhelming; however, as people are 10 times more likely to save for retirement at work than on their own, it may be better to provide some form of periodic payments in retirement through a worksite platform.
Cerulli reports that 75% of plan sponsors are now either actively seeking to retain or are willing to keep assets of separated employees in their plan. Both SECURE acts have made it easier and less risky for plans to provide retirement income solutions, leading some to predict that these seminal laws will do for retirement income what the 2006 Pension Protection Act did for TDFs.
The SECURE 2.0 Act has provisions to help participants consolidate their DC plan assets beyond industry collaborations like the Portability Services Network, a data exchange that includes five of the top record keepers (and growing) that administer plans for over 60 million participants. IRAs are under attack due to costs and conflicts of interest, as shown by the Department of Labor’s February 2020 prohibited transaction exemption, which makes a rollover recommendation a fiduciary act even if there was no previous relationship.
And more retirement plan alternatives are interested in providing wealth services, which could include retirement income solutions to participants as well as separated employees. With the growing use and lower prices, embedding annuities into managed accounts could meet the needs for more automatic personalization.
Though not a replacement for high-net-worth clients that can afford personal financial plans that adapt over time, in-plan retirement income makes sense for the vast majority of DC participants who do not have access to a financial advisor other than their plan’s financial advisor. So, in looking to facilitate a successful income journey for savers, the question is not whether there will be more in-plan retirement income solutions; the question is when and which solutions make the most sense.
