Defined Contribution

Breaking the Ice on Retirement Income Solutions—A Conversation Starter

Breaking the Ice on Retirement Income Solutions—A Conversation Starter
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3 min 47 sec

Retirement income solutions (RIS) have increasingly become a topic of conversation for defined contribution (DC) plan sponsors, mainly driven by these trends:

  • The 2019 SECURE Act, which helped clear the way for annuities in DC plans
  • A gradual shift in focus to the distribution phase of retirement
  • Longer life expectancy and increased concerns around longevity risk
  • An increase in plans seeking to retain retiree assets (83% of plans, according to Callan’s 2021 Defined Contribution Survey)
  • The shift away from traditional defined benefit (DB) plans as the primary source for funding retirement

Some sponsors have already implemented bespoke solutions in their plans; however, the overwhelming majority have either not explored or are only beginning to explore the full opportunity set of potential solutions. There are two major categories of income solutions: non-guaranteed and guaranteed. 

On the non-guaranteed side, many plans already have some of these solutions available to participants:

  • Stable value funds
  • Managed accounts (45% of plans, according to the DC Survey)
  • “Retirement” vintages of a target date fund (TDF) series

Additionally, managed payout funds are a developing area in the non-guaranteed category. These have a targeted payout percentage, and a participant can have an expected dollar income amount based on the amount invested.

Prevalence on the guaranteed side is much lower, as these are newer offerings available to DC plans, mainly in the form of annuities (12% of plans offered some form of annuities, according to the DC Survey):

  • Immediate annuities: allow a participant to purchase a stream of income at a single point in time
  • Qualified longevity annuity contracts (QLACs): a deferred annuity typically purchased around retirement age (e.g., 65) where payments begin between ages 80 to 85 (6% of plans, according to the DC Survey)
  • Unassigned deferred annuity products: a pooled annuity product that balances maintaining a level of liquidity with the potential to receive a stream of income. These can be thought of as call options on purchasing an annuity.
  • Guaranteed minimum withdrawal benefit (GMWB): similar to a managed payout fund, but the payout rate is guaranteed based on locking in an underlying portfolio value (5% of plans, according to the DC Survey)

There are many factors to consider when discussing if a retirement income solution makes sense and, if so, which are the appropriate ones. Below are some key questions to help guide the discussion:

What is the plan sponsor’s retiree/terminated asset policy?

  • An RIS may make sense if terminated employee assets are retained and/or there is a large population of retirees.

What are the characteristics of the plan participants?

  • An RIS may make sense if participant turnover is low and the majority are in the plan for the bulk of their careers.

Are there other income sources in retirement?

  • An RIS may make sense if a participant does not have access to a DB plan and/or Social Security.

What is the fiduciary structure?

  • An RIS may make sense if fiduciary resources are robust (e.g., knowledgeable, long-tenured committee and staff, with time and resources).

What is the fiduciary risk?

  • If plans are willing to be “first movers,” an RIS may make sense.

Is there buy-in from all parties?

  • An RIS may make sense if there is administrative support from the recordkeeper and support from the consultant, insurers, the legal department, and managers.

Will participants use the solution?

  • If use is expected to be high, an RIS may make sense.

What is the existing investment structure of the plan?

  • If a custom approach is taken, an RIS may make sense.

Is there a reason to offer the solution in the plan?

  • An RIS may make sense if there are concrete benefits to offering the solution in the plan.

Is a custom or off-the-shelf solution the right choice?

How should a solution be implemented—as a standalone solution or as part of a TDF series?

Will plan documents need to be updated to allow for more distribution flexibility (installments, periodic distributions)?

What sort of distributional flexibility can the recordkeeper accommodate?

One additional area to consider for plan sponsors that offer a defined benefit plan is looking at historical behavior, specifically if participants have taken a lump sum or an annuity distribution. This data can serve as a live case study and, if most participants are choosing a lump sum from their pension, it may be difficult to justify that they would use an income solution in the DC plan.

Key Takeaway: While prevalence is low, DC plans are increasingly adding a discussion of retirement income solutions to their agendas. Decisions about a potential solution require a robust thought process, and the aim of this blog post is to serve as a starting point to explore which, if any, solution may be appropriate for a particular plan.

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