The paper provides plan sponsors and other interested parties with a broad overview of potential retirement income strategies, the considerations of prudent implementation, and general information regarding new and emerging retirement income oriented strategy. NAGDCA said it is not intended to portray any particular strategy as superior to any other, but rather to highlight the trade-offs that plan sponsors should consider when reviewing options and provide a basic understanding of the differences that exist.
Upon separation from service, defined contribution plan participants have three fundamental choices: establish a payment stream, initiate a partial or full lump-sum withdrawal, or defer distributions. NAGDCA notes that a “one-size-fits-all” approach is not realistic because different participants will have different objectives and may have conflicting goals that will need to be sorted out as part of the decision-making process.
According to the paper, the following factors should be considered in evaluating various options:
- Conversion – Converting an account balance into a stream of income may appear to be an ideal objective for most plan participants. The risk for many participants is that they retire with a substantial account balance which might otherwise provide needed retirement income security, then undermine or squander that resource through periodic large withdrawals. However, participation in a defined benefit plan and/or Social Security may mitigate the need to convert plan assets to a retirement income stream.
- Longevity – Converting a balance to a retirement income stream is a beginning but not the end of an income strategy, because ideally the income stream will be commensurate with the participant’s remaining lifespan. For example, there is a 58% chance that one member of a married couple who are both healthy at age 65 will live to age 90, and a 30% chance that one will live to age 95.6. Additionally, as retirees live longer, inflation becomes a more serious risk to undermining the value of the income stream. With 2.5% annual inflation, today’s dollar loses over 50% of its purchasing power over 30 years. Given that one primary purpose of an income product is to ensure retirees don’t outlive their money, addressing inflation sensitivities is a necessary way to ensure that purchasing power remains steady throughout retirement.
- Risk Management – Risk management involves the tailoring of a retirement income strategy to a participant’s risk tolerance and investment objectives. This is no different than risk management for an active employee managing account balance accumulation, except to the degree that the participant’s retirement income objectives may dictate more conservative investment strategies or other de-risking strategies to address sequencing of return risk associated with a decumulation phase. Once again, there is no “one-size-fits-all” approach to risk management. Participants who are less dependent on their defined contribution accounts may be comfortable with taking on more risk. Participants who are extremely dependent on their accounts may not be able to take on any risk. Therefore, in evaluating retirement income strategies it’s important to ensure that the strategy (or range of strategies) provides for benefit flexibility for participants who have different relationships to risk.
Factors to consider (cont.):
- Utility – There is tremendous variation in the range of participant circumstances upon retirement. While plan sponsors may assume that many, if not most, plan participants may be best served by converting their defined contribution balances into retirement income streams, this will not be true of all plan participants. In addition, plan sponsors may feel the need to empower participants looking for lifetime income with full flexibility and control over their account value to address unexpected events like health status changes that may impact participants’ objectives down the road. The plan sponsor may then wish to provide options that allow for participant flexibility. Non-product tools that allow participants to make changes to their distribution elections as needs and circumstances change over time are an important resource for this segment of the retired population.
- Communication – The responsibility placed upon plan participants in a defined contribution plan (i.e., decisions related to a proper deferral rate, investment choices, and asset allocations) during employment can be overwhelming. The responsibility to create a retirement income stream is an additional complexity and has tremendous ramifications. Therefore, it is important for plan sponsors to evaluate any product or service available in their plan against the benchmark of whether and to what degree participants will respond positively to the concept. If participants cannot be realistically expected to understand the option being presented to them, it’s unrealistic to expect that they will be able to make appropriate decisions about those options. This is why plan sponsors should, in approaching the development of retirement income strategies, invest the time and effort to gauge the communications burden and effectiveness of individual strategies and the possibility of other strategies. Even if a strategy by itself can be understood, if it’s part of a broader constellation that becomes overwhelming to participants, it may still become ineffective. Focus groups and surveys can be important tools of understanding how your participants experience the products or services under consideration.
- Administration – Plan sponsors should evaluate the administrative burdens placed on them to provide potential retirement income strategies in the same way that they evaluate administrative burdens for any other product or service associated with their plans. These potential burdens include those associated with procuring and executing contracts with service providers; communications; consulting expenses; required staffing resources; and ongoing oversight and monitoring. If the needs of the strategy are not commensurate with the resources available to administer it, it may not be appropriate to implement it. On the other hand, effective retirement income strategies may provide benefits for more effective workforce management. As employers identify retirement income strategies that meet the needs of their participants, they may see more predictability and stability within the workforce.
- Portability – Plan sponsors must also consider the ability of, and limitations on, transitioning a particular benefit as the plan and its service providers evolve over time. Non-product tools such as period payment streams provided through a third-party-administrator may be relatively easier to transfer from one administrator to another while product tools may create more challenges. Given this, the portability of any proposed strategy must be evaluated before it is adopted into the plan.
The paper goes on to discuss retirement income strategies, including non-product strategies and various annuity options.
The white paper is here.