As more and more retirement plan participants are depending on defined contribution (DC) plans to save for a comfortable retirement, they not only must make decisions regarding saving and investment strategies, but they must also decide on a withdrawal strategy for retirement.
Without a strategy, retirees my want to withdraw as much as possible to support their pre-retirement lifestyle; however, resources may fall short of maintaining this lifestyle, particularly with increased life expectancies.
According to retirement industry sources, the key to a financially successful retirement is education, particularly early education. Garry Spence, head of plan sponsor experience and participant engagement, retirement plan services, for Lincoln Financial Group says, “The educational piece is crucial—how we deliver the story from accumulation through the distribution process of achieving a participants retirement dreams.”
Education about savings
“Why is this true?” Spence queries. “The auto tools are the most successful ways for getting people into a plan, without a doubt, but if you’ve got people enrolled at 3% to 4% and they think that’s going to get them though to a meaningful retirement, sadly that won’t work. You cannot hit your goals if you don’t get the educational piece that goes with automatic design features including that participants need to gradually increase that contribution amount.”
According to the 2017 Lincoln Retirement Power Participant Survey, two-thirds of retirement plan participants understand that they should be saving at least 10% of their salary to stay on track with their retirement savings needs, and 45% believe they need to save 15% or more—which aligns with general industry recommendations. However, only four in 10 savers are saving as much as they think is necessary, and among the savers who are saving less than what they think they need, the majority (68%) would need to increase their savings by 5% or more to be on track.
Sri Reddy, senior vice president and head of full service investments for Prudential Retirement in Hartford says, “Prudential has fully embraced the notion of financial wellness, which is a conversation we have with participants from day one of when they start working. That way the conversation about engagement for decumulation is not a one and done event. You are always thinking about your financial well-being the same as you are thinking about your health well-being.”
“We start with the basics, paying off loans, saving for a first home, deciding to spend the first raise you get on your new family or saving it for retirement,” Reddy continues. “As participants age, we address diversifying investments the right way, and then when they reach age 65, they’ll be fine because on top of everything else they have Social Security, and we’ve helped them save for retirement inside and outside of the plan. If they follow the things they’ve learned along the way, they can decumulate appropriately as well.”
Education about how much retirement income is needed
Part of the education piece are the calculators and apps that providers have created to help participants understand how their money can grow in the accumulation phase and how much retirement income they will need on a monthly basis over years in retirement. Providers are also illustrating the lifetime income value of retirement benefits on participant statements so that participants don’t focus on the account balance but instead what it translates into. But participants also need to be educated about life expectancy, health care costs, and how much Social Security will provide for them.
Darren Headley, consultant for Pavilion Advisory Group in Chicago says, “Plan administrators are investing in technology for participant use that will help them address the question of how much can they withdraw in retirement. This investment has led to the development of online tools for participant use that incorporate scenario analysis that takes into account assumptions on mortality, health care costs, Social Security income, as well as other assets held outside of their defined contribution plan in an attempt to provide participants with a more comprehensive view of how long their savings will last based on various withdrawal scenarios.”
Reddy says, “We need to think about the truth about longevity. People are living longer than they were. Looking at shared longevity of married couples and how long they need to plan for retirement is a very good eye opener for participants.” The Society of Actuaries RP-2014 Mortality Table projected with Mortality Improvement Scale MP-2014 as of 2015 shows that at least one survivor of a 65 year old couple today has a 50% chance of reaching age 94 and a 25% chance of reaching age 98.
Part of a retirement draw down plan is life expectancy. Spence says, “You have to be healthy to enjoy retirement to begin with. Health is the most important component. People are living longer but it’s important for them to live a healthier longer lifestyle. If you don’t then you have a lot more medical expenses in retirement. We help them plan towards a longer lifestyle so they never run out of money.”
Reddy says retirement plan sponsors and advisers really need to educate participants about the nuances of Social Security as well. “For instance, there are three distinct components of Social Security—what full retirement benefits are and when they start, the value of deferring Social Security if they have other means to retire with full retirement benefits, and that there are different benefit structures depending on whether you are married, or if you are taking a spousal benefit—in other words not all Social Security payments are created alike.”
Reddy adds, “You have your 401(k) as a foundation plus Social Security, and people need to think about non-discretionary expenses not covered by Social Security such as health insurance or property taxes—things that you need to know you have provisions for. How do you create them? There are different ways to do it. You can take it out on your own through systematic withdrawals through a best effort basis, and whenever the market is doing well, you have to plan on being conservative, you have to take out a lower withdrawal rate like 3.5% or 4%.”
Education about tools for creating an income stream
In the past, income streams from Social Security and defined benefit (DB) plans were important to so many Americans, Spence says. “They took care of [retirees’] basic living expenses such as their property taxes, utilities and medical costs. [Retirees] would have a baseline of income that would support them and then if individuals wanted to, they could earn some extra income on the side for their joy expenses, some of the things they wanted to do on their vacations.”
He adds, “I think today you are seeing a trend going back to an income stream that can be done through annuities. You’ll see a lot of people looking for an income stream because people need to be extremely disciplined to manage withdrawals properly because of behavior such as impulse buys. If cash is available, you may make a large spend, but implementing an income stream helps you become more disciplined.”
Spence suggests plan sponsors should offer participants all the options available now, including systematic withdrawals and annuities, which would provide an income stream. But, retirement plan participants need to be truly educated that once this money is spent, it’s gone.
Advisers are providing plan sponsors with education on establishing a retirement tier; the different types of decumulation products available, such as managed payout funds or annuities; and helping their clients navigate the market to better understand what could be appropriate or valuable for their participants, says Headley.
Reddy says, “Sponsors can do this through a pooled mortality contract such as an annuity and then there are other hybrid versions such as guaranteed minimum withdrawal benefits (GMWBs) that are offered in a 401(k) plan or are available in the retail market. Another form of guaranteed income protection that plan sponsors are beginning to use is a qualified longevity annuity contract (QLAC), which participants can set for a future date and have peace of mind that they have a safety net.
Many plan sponsors are thinking about incorporating lifetime income solutions as an investment option within their retirement plans, Reddy continues. “Many of the plans that we do business with incorporate lifetime income into a target-date fund, for instance. It’s very easy for participants to roll into them and for them to understand how they work. They know there is an amount they can take out every month or every year regardless of how the market performs.”
Spence sees retirement as an emotional experience. He says, “People have to have that purpose, that identity and that compelling reason to move forward towards something. And if they don’t have the financial resources to fill that dream then they cannot move forward to live that next phase of life. I think it’s important that people understand that.”
« DB Q&A: Plan Sponsor Pilot Mediation Project