Making the In-Plan Guaranteed Income Decision

During a webcast sponsored by the National Association of Government Defined Contribution Administrators, Bozeman explained that participants face three dilemmas: not knowing how much to save, not knowing how to invest their savings and not knowing how to generate an income stream in retirement. Plan design features can address the first dilemma, target-date funds solve the second and guaranteed income products can help with the third.  

Bozeman contended the industry is about to enter the next phase of defined contribution (DC) plan investing. He pointed to a BlackRock survey that found workers and sponsors agree on the importance of secure income-generating options in their workplace retirement plan. Nearly nine out of 10 (86%) sponsors agree (and 20% agree a “great deal”) that their participants would benefit from an in-plan guaranteed solution, and 89% of workers agree on the importance of these income options (see “Sponsors Think Employees Will Have to Keep Working”).  However, the survey also found very few employers offer in-plan guaranteed solutions.   

A poll of webcast participants about why they are hesitant to adopt in-plan guaranteed income solutions for their retirement plans found most are concerned with operational and implementation complexity, followed by costs, fiduciary concerns and lack of familiarity with products.  

According to Bozeman, ideally, DC income products will provide relative certainty, simplicity, feedback, and flexibility in a cost effective structure that is designed to comprehensively meet participants’ retirement needs. 

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Decisions, Decisions…  

When making the decision to offer in-plan guaranteed income options, Richard Turner, vice president and deputy general counsel at VALIC, said plan sponsors should ask should I get involved, and if I do, what are my potential risks and liabilities? Then, it should be a participant-focused decision: What can I do to maximize potential for participant success? According to Turner, key risk factors for participants include longevity, inflation and returns; the amount and timing of withdrawals; the ability to pool return risk; and participants cognitive ability in later years to follow through with financial strategies.  

Turner noted that Employee Retirement Income Security Act (ERISA) fiduciary rules apply to the selection of a guaranteed income product provider and participant education and advice. Non-ERISA plans may be subject to other fiduciary rules of the state or related to trustees of assets.  

There are three main forms of lifetime income guarantees: required minimum distributions (RMDs), annuities and guaranteed minimum withdrawal or income benefits (GMWB or GMIB). Turner explained that with RMDs, for which the calculation uses life expectancy tables, since life expectancy never goes to zero, they effectively last a participant’s lifetime.  

With annuities, participants will focus on annuitizing a portion, not all, of retirement savings, he said. Deferred annuities start at a certain commencement date in the future, immediate annuities start after the purchase. There are fixed or variable annuities which offer either a fixed payment amount or one that varies with market fluctuations. And, annuities can either pay participants for life or for a period certain.  

GMWBs and GMIBs are attached to a participant’s existing account balance, and provide either a guarantees of a minimum withdrawal (the account remains in accumulation) or a minimum annuity. With a GMWB, withdrawals can continue even after an account is depleted. With a GMIB, there is a minimum annuity regardless of account balance.

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Evaluating Products  

Even if a plan is not governed by ERISA, a plan sponsor will want a formal review process to be an informed buyer, said Jayson Davidson, CFA, senior consultant at Hyas Group.

According to Davidson, key evaluation areas to consider are the variety and quality of investments. Look at underlying investment options of the products and ask if their quality is strong enough to warrant offering to participants. Plan sponsors should also look at fees, and Davidson noted that in addition to fees related to investments, insurance companies charge a fee to guarantee that a participant can make withdrawals (even if the market value falls to $0), and they may or may not reserve the right to increase the fee.  

Plan sponsors should also consider portability of the product if a participant separates from service, if the plan’s recordkeeper changes or if the product is eliminated as an investment option. Can participants redeem the market value of their shares at any time? Other areas for evaluation include the guaranteed withdrawal rates and policies and the guarantor’s credit quality and the state’s guarantee level; if the insurer becomes insolvent, claims will go the state.  

While product evaluation can be very involved, Davidson contended the pros of offering participants an in-plan guaranteed income option outweigh the cons. “The pro of guaranteeing retirement income itself is reason to consider such products,” he said. He added that current regulations do not provide a highly specific analytical roadmap, but the industry can expect more regulations about these products as the federal government considers retirement income in general.  

A copy of the webcast presentation with a checklist of questions for evaluating guaranteed income products is at http://www.nagdca.org/documents/Combined_Presentation.pdf.