Beyond Auto-Enrollment: Decumulation and Retirement Income

The fourth and final article in a series about how to boost retirement plan participant engagement and outcomes beyond automatically enrolling employees.

Getting retirement plan participants to save at appropriate levels and providing advice and financial wellness education can help them in the process of accumulating savings for retirement.

For plan sponsors with a long view—one stretching beyond saving, down the lengthening span of retirement years—helping participants plan for decumulation seems increasingly important.

But having to choose from the array of products now targeting this trend is only complicated by the dearth of clear regulations detailing how to use them. Faced with so many uncertainties—risk of fiduciary breach among them—plan sponsors may wonder how to proceed.

They wouldn’t be alone. “Bill Sharpe, a Nobel Prize winner for economics, said, ‘Retirement-income planning is the hardest problem I’ve ever looked at,’” repeats Steve Vernon, a retirement adviser at the nonprofit Institutional Retirement Income Council.

For all the variables, two things are definite: Good options are available, both product-driven and not, and participants need good education to understand them. Plan sponsors wanting to add decumulation features need to study the different methods—seeking help from their adviser if they have one—implement those features best suited to their plan and workers, then supply educational materials that clarify what they do.

There are basically two different methods for producing an income stream, post-retirement. These are 1) systematic withdrawals, where the participant draws down money from his investments, and 2) annuities, which he may purchase through the plan—if these are offered—or outside it, says Vernon, also a consulting research scholar at the Stanford Center on Longevity. The Center on Longevity recommends a combination of these—what it calls a portfolio approach.

NEXT: Systematic withdrawals and/or annuities

For plan sponsors leery of products, systematic withdrawals generate retirement income through the plan; no product must be purchased. “Many plans have installment payment features where you can pay out a monthly or quarterly amount; it can be a dollar amount or a percent of your assets,” Vernon says. (See “Drawing Down.”)

Another strategy that the Center for Longevity has tested is the aforementioned portfolio approach. Here, the participant builds a floor consisting of one or more sources of guaranteed income—Social Security, a pension, maybe an annuity—“which won’t go down with the stock market and will last as long as you do,” he says. Money from these will cover basic living expenses. The rest of the participant’s savings can be invested aggressively and used at discretion, say for travel, hobbies or gifts, he says. This strategy resembles an investment portfolio, except that the bond portion is now a guaranteed lifetime income source.

This is especially effective when the market plummets, he says. Withdrawing money from investments in decline is “the worst thing you can do. The floor psychologically helps people. They think, ‘I have a roof over my head and food on the table.’ They can let the money ride.”

This is an approach plan sponsors can facilitate, he says. The employer could offer an annuity through the plan or upon distribution, then educate employees about the strategy, with its pros and cons. Vernon admits that some plan sponsors have been hesitant, afraid of the fiduciary risk. He believes, however, that, consulting with an Employee Retirement Income Security Act (ERISA) attorney will show that raising awareness in this way is just sharing information. “Where the advice line gets crossed is to say, ‘This is what you should do,’” he says.

NEXT: Robust offerings now

Some plan sponsors, though, have put off adding products for other reasons. “I’ve heard some say, ‘I want to wait for the market to evolve,’” Vernon says. “My answer is, ‘There are plenty of good, credible ways now to generate retirement income.’ Not to say there might not be more innovation in the future, but there are robust offerings now, and plan sponsors that are motivated don’t have to wait.”

Traditional annuities are rarely seen in retirement plans, he says. More typical are products such as guaranteed lifetime withdrawal benefits (GLWBs), Prudential’s IncomeFlex is an example. “The insurance companies have been fairly innovative in developing insurance features that could be placed inside a plan,” he says.

One innovative product that Vernon likes functions outside the plan. “If you look under the hood, it’s like an IRA rollover—the money comes out of the plan and goes to [a vendor, for example Hueler Income Solutions]. It bids out an annuity to various insurance companies and takes the highest bidder at the time for each retiree.”

He calls this “a fairly clean way for the plan sponsor to have an annuity, because money doesn’t stay in the plan.  [You can tell participants], ‘If you want an annuity, we’ll arrange to send your money over to Income Solutions,’” he says.

Of the annuity products available, Stewart Lawrence, senior vice president, national retirement practice leader with The Segal Group, most likes longevity, or deferred, annuities, which begin to pay back when the retiree reaches 85. Today’s low interest rates make these expensive, though, he says. Assuming that rates will climb, a retiree could spread out the purchase—five payments over five years—to average out the cost. Keep in mind, however, that this will mean five processing fees, versus just the one, Lawrence says.

He notes that these annuities are garnering more interest since the Department of Labor (DOL) revised its regulations to permit 70-year-olds beginning their Social Security benefit to roll money into them, tax-free.

He is less impressed with lifetime income, or immediate, annuities, which he describes as the opposite of life insurance: Make one grand payment and immediately begin to receive small payments back.

Another option Vernon likes is managed payout funds. “Those might be good for someone who has money in an IRA and doesn’t want to think hard about it.” The account holder would request that his money be transferred into a managed payout fund. He then receives automatic monthly payments—typically a fixed percent. This may be the retiree’s entire savings, Vernon says, possibly a consolidation of several defined contribution accounts and/or IRAs. A benefit is that the company performs asset allocation on the account—“even more critical after retirement compared with accumulating money before,” Vernon says.

NEXT: Educating participants about options

As educating near-retirees about the options for their money is one of its fiduciary roles, plan sponsors still afraid of liability could recommend their near-retirees talk to an advisory service. Today, increasingly, plan administrators supply this option, Vernon says. As in hiring any other fiduciary adviser, the sponsor must ensure that person meets ERISA’s standards. Either way, it is critical that participants be counseled. Vernon offers up another quote, this one by behavioral scientist Richard Thaler: “Asking Americans to solve their own retirement problems is like asking them to build their own car.”

A problem no consultation will fix, though, is the inadequate savings of roughly half the population, Vernon says. “The more important decisions [concern] how long to keep working, delaying Social Security and cutting living expenses. Those will have more of an impact than how you draw down your savings.”

One suggestion for drawing down an employer-sponsored retirement plan, says Lawrence: Spend it as quickly as you can. A bit of hyperbole—the retiree would actually receive monthly checks—but the advice makes a point, he says. The subject of drawing down one’s retirement savings is highly complex, and the best strategy for some may be the worst for others. “Everyone’s situation is different,” he says.           

To stress the fact, Lawrence ticks off just a few of the variables that would contribute to a drawdown strategy: presence or absence of other retirement plans left behind, individual retirement accounts (IRAs), Social Security, a spouse’s income, post-retirement pay, and the presence of Roth savings.

Strategizing is key: weighing the employee’s variables, then leveraging his available income sources to produce the greatest yield. Using Lawrence’s suggestion, a 65-year-old retiree would, over five years, spend down his defined contribution (DC) plan. Meanwhile, he leaves his Social Security to ripen until he turns 70, the maximum age to start collecting. Lawrence applies the 3% rule, which would give the retiree $1,000 to live on each month for that first five years, totaling $60,000. At that point, he would begin taking Social Security and could invest the remainder of his retirement plan. “That may be the strategy for some people,” Lawrence says.

This scenario ignores one significant variable, however: the stock market. Lawrence notes that, in the simplest take on the 3% or 4% rule, the withdrawal amount is fixed at retirement. If stock prices fall, “you can deplete the account very quickly,” he says. “I like taking 3% of whatever’s there. So if the market crashes, you take 3% of the lower balance and you live on that. It’s a tough year, but when the market goes up, you get a raise every year by taking out the same 3%.”

For any strategy, delaying Social Security is a good idea, and plan sponsors can aid their participants simply by explaining how that measure helps. For the participant who needs to retire at 65, the plan sponsor could enable him to postpone the benefit by adding a temporary payout feature to the plan, Vernon says. This systematic withdrawal scheme would last until the retiree was 70, paying him the monthly amount Social Security eventually would when he reached that age.

“That’s an example of a retirement income solution supported by a lot of research and that helps participants make more effective decisions,” he says. “By setting that up administratively and making it easy for the participant to check the box and implement, the sponsor is doing its participants a favor.”