Retirement Income: New and Improved

Coming out of the 2008 financial mess were tales of scores of workers delaying retirement and retirees returning to work. “We all know people who planned to retire but couldn’t after the fourth quarter of 2008,” says Charlie Nelson, President of Great-West Retirement Services in Greenwood Village, Colorado.  Market volatility wreaked havoc on defined contribution and IRA assets that had no income guarantees or downside protection. 

Market volatility led to participants and retirees looking at retirement investments in a whole new light. According to a 2009 Merrill Lynch survey, 56% of participants surveyed stated that the economic volatility of 2008 and 2009 made them look at retirement differently, and 51% said they wished they had spent more time planning for retirement, says Katherine Roy, Head of Personal Retirement Innovations with Merrill Lynch Wealth Management. 

With employees delaying retirement or former employees clamoring to return to work, sponsors began reconsidering how retirement income is provided to workers. There has been a lot of conversation regarding retirement income, particularly delivery, says David Wray, President of the Profit Sharing/401K Council of America in Chicago.  There is new focus on providing a less volatile experience to participants, he says. 

Historically, the problem has been that the typical defined contribution account does not translate into a guaranteed stream of retirement income payments, but there were not any workable solutions to provide participants with steady retirement income. Previously, says Nelson, products providing guaranteed retirement income were retrofitted and did not work well in defined contribution plans.  

Sponsors now are showing more interest in providing retirement income products designed exclusively for the defined contribution market, says Nelson. In response, vendors are creating a new generation of retirement income products, designed specifically to fit inside defined contribution plans, says Nelson. Newer generation products address retirement plan issues such as qualified domestic relations orders and fiduciary liability, he says. Additionally, the newer products are portable, so there are no hindrances if, for example, the recordkeeper is changed. 

Some new products allow participants to dollar-cost-average the purchase of an income stream with the money put into a defined contribution plan, rather than just stocks and bonds, says Wray.

Other new products offer participants insurance protection five to 10 years prior to retirement to protect against volatility, says Wray. Sponsors now can offer participants the option to buy wrappers that preserve principal, he says. Participants enjoy the advantages when the market goes up, but it still provides a steady check, says Nelson.

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One example of these wrap products is Great-West’s SecureFoundation®.  SecureFoundation is a product designed for the defined contribution market that provides benefit protections as of a date certain, e.g., after age 55. Great-West charges 90 basis points in addition to the underlying investment management fees. However, says Nelson, the additional fees do not have to be paid over the participant’s entire lifetime, but only in the last 10 years prior to retirement. For example, he says, if a participant wants to retire at age 65, he can start paying for the protection when he is 55. 

Wray notes that, while these wrappers do dampen volatility, they also reduce overall returns because participants are charged for them. Nelson, however, compares it to buying insurance. People typically buy insurance to protect their house or their car, he says; now, they can buy insurance to protect their retirement. 

Furthermore, argues Nelson, by buying these wrappers, participants can maintain a higher equity exposure, which could counteract the additional cost. In the defined contribution markets, glide paths typically reduce equity exposure as participants near retirement, says Nelson,  but the new products allow participants to have higher equity exposure than they might otherwise have had because the income is protected. Rather than reduce equity exposure when nearing retirement, participants can buy insurance, keep their equity exposure, and benefit if the market goes up. 

Sponsors are looking at these new products, says Wray, but there has not been a big take-up rate because they are new.  

Outside the plan, the retirement income market traditionally has been dominated by individual variable annuities, says Nelson. While there have been a number of changes recently, he says, costs increased significantly since the fourth quarter of 2008, primarily because of hedging costs providers pay to make the guarantees.  

However, things are changing even in this market. People want to stay actively invested in the equity market, says Nelson, so we are seeing a trend of having ’40 Act mutual funds with retirement income product wrapped around them.   

Vendors also are coming through with products to help retirees manage their retirement income flow. Merrill Lynch Global Wealth Management recently launched My Retirement Income™, says Roy, which connects customized retirement income planning with the Bank of America, N.A., retail banking network. My Retirement Income allows clients nearing or in retirement to plan out for the long run their retirement income, and execute it to get a paycheck.  

There even have been changes on the sponsor side. To get around limitations presented when annuities are offered as a distribution vehicle inside the plan (see “Holding Patterns,” below), vendors are creating products that employers can offer outside the plan, says Wray. Participants can roll over their money into an IRA and be delivered an institutionally priced annuity. This way, says Wray, the annuity is a lot less expensive than if employees were to buy them on their own.  

Had these products been available prior to the financial crisis, says Nelson, participants near retirement and retirees could have been somewhat protected. That is what is driving plan sponsors and participants to look at these products despite the extra costs, he says.

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 SIDEBAR: 

Holding Patterns 

While offering an annuity as a distribution option through the plan seems to make sense, it is unlikely that sponsors will move in that direction. “I don’t think you’ll see annui­tization out of plans until the regulatory regime changes,” says David Wray, President of the Profit Sharing/401K Council of America in Chicago. 

When annuities are offered through the plan, explains Wray, current rules and regulations make them undesirable to most participants. Annuities purchased through the plan must meet the Joint and Survivor regime and have gender-neutral pricing—making them undesirable to men. Men have shorter life-spans, explains Wray, so annuity pricing for them is cheaper outside the plan.  

Additionally, says Wray, when annuities are a defined contribution plan distribution option, it has to be all or nothing; either 100% of defined contribution assets must go to the annuity purchase, or nothing. Few participants want to annuitize their entire benefit, says Wray. Those who are 65 could live to be 85, so they need to stay invested in equities to retain purchasing power and not annuitize their entire account.  

Another factor that makes sponsors hesitant to offer annuities, says Wray, is the liability issue. When employers choose an insurance company to offer annuities to their employees, he explains, they are exposing the organization to liability should that insurance company go out of business, leaving employees’ annuity contracts worthless.