Casting DC Plans in a Retirement Income Light

Mike Sasso, partner and co-founder of Portfolio Evaluations told attendees of the 2019 Plan Sponsor Council of America’s Annual Conference that defined contribution retirement plans are not “plans.” Rather, he said, they are savings vehicles.

He said he doesn’t think a new fiduciary safe harbor for selecting annuity providers is going to open the floodgates of plan sponsors adopting annuity options in their plans. But, plan sponsors are having conversations about the purpose of their defined contribution (DC) plans, and how to help employees establish a source of retirement income. “This is one reason more plan sponsors want employees to keep their assets in the plan after retirement,” he said. He added that offering installments as a distribution option in the DC plan is a “no-brainer” for plan sponsors.

Dr. Zvi Bodie, the Norman and Adele Barron professor of management at Boston University, told conference attendees that in order to help participants with retirement income, plan sponsors must turn their thinking to life cycle finances. Instead of looking at wealth accumulation, the gauge should be a standard of living over a lifetime.

“An income goal is different from a wealth goal,” he said. “The risk to be addressed should be the income shortfall, not returns on investments.” He added that diversification should not be the only risk management technique in DC plans. There should be hedging—eliminating the downside by eliminating the upside—and insurance—eliminating the downside for and insuring the upside for a premium.

“We want to add to Social Security inflation-protected income for participants,” Bodie said. “Annuitization with inflation protection should be the default distribution option, with the ability to opt out.”

Bodie presented 10 key design principles for DC plan sponsors:

● Set replacement income as the goal for retirement;

● Address risks relevant to the goal: income shortfall, not return volatility;

● Deliver an asset allocation strategy to manage retirement income risk;

● Make efficient use of all dedicated retirement assets;

● Offer personalization based on one’s retirement account characteristics;

● Take account of changes in both market and personal circumstances;

● Be effective even for those who are completely unengaged;

● Supply only meaningful information and offer actionable choices to improve outlook;

● Offer robust, scalable and low cost investment strategies; and

● Offer seamless transition and payout flexibility at retirement.

Bodie compared the evaluation of the income shortfall to that of evaluating funding shortfalls in defined benefit (DB) plans. A certain replacement income in order to achieve the standard of living a participant wants in retirement is the goal, and the plan should use dynamic strategies, as DB plans use liability-driven investing (LDI), to close any shortfall and achieve the replacement income goal. “LDI in a DC plan is the funded ratio of each participant’s goal,” he said.

Bodie pointed out that target-date funds (TDFs) do not take into account the short- and long-term risks of stocks. The allocation should be adjusted over time. “TDF glide paths are pre-determined no matter what happens. That’s nuts!” Brodie exclaimed. “TDFs should be more dynamic.”

Louis Belluci, associate director of U.S. equity indices at Standard & Poor’s Dow Jones Indices, told attendees he is seeing an evolution in TDFs. “When considering the goal is retirement income, more TDF managers are considering a glidepath that moves from mostly global equities to mostly global bonds ad then at retirement switches to more secure investment vehicles, such as Treasury inflation-protected securities (TIPS),” he said. “It’s more like an LDI glidepath.”