Actuaries Weigh Income Options for DC Plans

Structured income solutions should be a part of DC retirement plans, according to a paper from the Stanford Center on Longevity and the Society of Actuaries’ Committee on Post-Retirement Needs and Risks, and the qualified default retirement income alternative (QDRIA) is one possibility.

DC plan participants face another important challenge as they approach and enter retirement—turning their savings into a reliable source of retirement income. A good solution would be implementing some form of income product within DC plans, according to the two groups’ joint research paper.

Last fall, the two organizations concluded in another paper that it would be desirable for DC plans to include an organized approach to providing retirement income with the potential to last the lifetime of a plan participant. (See “Actuaries Encourage Offering Retirement Income Solutions.”)

This year, they outline actual methods in “Foundations in Research for Regulatory Guidelines on the Design and Operation of Retirement Income Solutions in DC Plans.” The paper gives an overview of existing and proposed regulatory guidance, including background on ERISA 404(c) requirements. Researchers also examine safe harbor guidance on programs that offer retirement income. The paper considers three distinct core retirement income options, along with details on systematic withdrawals and annuity purchases, among other topics.

With the prevalence of DC plans, participants bear the responsibility for deciding how much to save and how to invest their contributions while they are working, the paper points out. In recent years, plan sponsors have implemented features such as auto-enrollment, auto-escalation of contributions, design of the investment lineup of funds under Section 404(c) of the Employee Retirement Income Security Act (ERISA), and qualified default investment alternatives (QDIAs) to address these challenges. Recent legislative and regulatory guidelines provided significant encouragement to plan sponsors to adopt these features and are widely credited for improving the performance of the DC retirement system.

How to convert savings into a reliable source of retirement income is another emerging challenge for many DC plan participants. Many workers lack the sufficient financial literacy to generate effective retirement income strategies, which can be a complex retirement planning task.

The paper outlines some of the advantages of having plan sponsors take part in helping workers use their DC accounts to generate sustainable retirement income. First, large employers or their plan administrators may have the resources needed to conduct the due diligence to select, implement and communicate retirement income programs—tasks that are difficult for untrained individuals. Plan sponsors or plan administrators can significantly increase the odds that retirement solutions will be adopted if they make it easy for retiring employees to elect and implement a solution.

Next, plan sponsors can be the unbiased institutions that act solely on behalf of their plan participants, without regard to financial compensation that might depend on participants’ elections. It’s the responsibility of plan fiduciaries to act in the best interests of plan participants. Institutional pricing and competitive annuity bidding platforms available to plan sponsors can significantly increase retirement incomes, compared with retail solutions.

In short, plan sponsors can deploy bargaining power, scale, ability to standardize, and distribution efficiency to improve the retirement security of plan participants.

Employers and plan sponsors have benefited from safe harbor guidelines under ERISA 404(c) and for QDIAs that apply to the investment menu in the accumulation phase. If there were analogous safe harbor guidance for the design and implementation of a program of retirement income that applies during the decumulation or retirement phase, employers and plan sponsors would be encouraged to implement such programs, the paper contends.

The plan sponsor that complies with such safe harbor guidance in the design, implementation and disclosure of a program of retirement income would be protected against claims of fiduciary breach in the event that a retiree experiences unfavorable outcomes, including outliving assets, reduction in the amount of retirement income after it has commenced, and/or the drawing of retirement income that does not keep pace with inflation. The safe harbor would be a defense against participants’ allegations that an inappropriate form of retirement income was offered by the plan or that the plan selected the wrong specific product to implement the retirement income strategy.

Such safe harbor guidance would not require a plan sponsor to implement a program of retirement income. Putting in retirement income would be voluntary, and plan sponsors could still offer a lump sum payment as one of the payment options.

Three general methods for generating retirement income from savings are outlined, with distinct characteristics regarding the amount of periodic retirement income, the length of time the income is expected to be paid, access to savings, guarantees of lifetime income, and the circumstances under which the amount of income could change:

• Systematic withdrawals: Invest assets and draw down the principal and investment earnings with a formal method intended—though not guaranteed—to make the money last for life.

• Annuities: Transfer savings to an insurance company that guarantees a lifetime retirement income. Note that some insurance company products provide this guarantee but do not use the name “annuity” in their disclosures and marketing materials.

• Period-certain payouts: Invest assets and make periodic payments over a fixed period, after which the assets devoted to this solution are exhausted and payments stop.

The paper explores safe harbor guidelines for a program of retirement income somewhat modeled on the structure and content of the safe harbor guidelines under ERISA 404(c) for the investment menu. For example, safe harbor guidelines for a program of retirement income could, among other things, require that a plan:

• Offer at least three core retirement income generators that have distinct characteristics regarding the amount of periodic retirement income, the length of time the income is expected to be paid, access to capital, guarantees of lifetime income, and the circumstances under which the amount of income could change. These options could be offered in the period leading up to retirement, at retirement and after retirement.

• Designate a default retirement income solution that complies with requirements for a QDRIA, should a participant fail to make a positive election of a retirement income solution or a lump sum payment.

• Enable the participant to allocate funds freely among the retirement income generators offered, at the time the participant chooses the retirement income solution.

• Provide sufficient disclosure to enable participants to make informed decisions to select a retirement income solution.

The plan sponsor would still be responsible for conducting the necessary due diligence to select financial institutions, products and services that are appropriate to implement programs and features after choosing the design of the retirement income program, and to monitor such products and services on an ongoing basis to ensure that they continue to meet the needs of plan participants.

“Foundations in Research for Regulatory Guidelines on the Design and Operation of Retirement Income Solutions in DC Plans” can be downloaded from the website of the Stanford Center on Longevity.