Evaluating Options

As Baby Boomers reach traditional retirement age at a staggering pace, it is no secret that retirement income options are discussed more frequently to help retirees secure a steady stream of income from their net retirement savings.

Many workers realize their financial future is up to them, and they want to know how they can count on a secure income. A May 2011 survey from BlackRock found nearly two-thirds (62%) of employees would prefer to receive a steady stream of income at retirement, and 40% of employees would like a “great deal more information” about generating secure income from their savings.

However, while some plan sponsors are hearing the retirement income request loud and clear, the number taking action is fairly low. According to the BlackRock survey, just 13% of plan sponsors feel a “great deal of responsibility” for helping employees secure an income stream in retirement, and only 25% want to offer employees a “great deal more information” about how to generate secure income.

Despite the low interest from plan sponsors in adding income products to the 401(k) plan, advisers are poised to help with the required investment selection due diligence for when plan sponsors are ready to make that leap—or simply want to understand more about their options.

Recent guidance from the U.S. Treasury Department, designed to make it easier for retirees to choose to receive their benefits as a stream of income in regular payments during their lifetime, will help the retirement income conversation move forward, says Joe Lee, head of U.S. DC Advisor-Sold Distribution at BlackRock (see “Stream of Income” page 18).

In order to guide plan sponsors, however, advisers must first do their homework to understand the types of products in the marketplace, how they integrate with recordkeeping systems and how plan designs can maximize the potential for participants to save enough money to reach their goals. Along the way, participants should have options that enable them to diversify their investments, including purchasing income-producing vehicles within the plan, Lee suggests.

 As more plan sponsors start focusing on retaining retiree assets in the plan, they are evaluating what investment solutions are needed, as well as how to support the communication or decisionmaking around retirement income issues, says Stacy Schaus, defined contribution practice leader at PIMCO.

“There’s increasing interest among plan sponsors in retaining retiree assets in the plan, which necessitates a close look at the appropriateness of the investment lineup and consideration of retirement income solutions,” Schaus says.

Here are five key areas industry experts suggest advisers consider and discuss with clients when evaluating retirement income options:

1) Recordkeeping. As with any investment selection, when choosing a retirement income option, it is crucial to select what is in the best interest of the participants and their beneficiaries. However, retirement income options have some challenges because many recordkeeping platforms do not offer the products. Presently, advisers have a lot of influence driving recordkeepers to build their programs so that they accommodate more retirement income options, Lee says.

He suggests advisers talk to recordkeepers about how the retirement income option will actually appear in the recordkeeping system and in statements.

When adding a retirement income product, the plan adviser should work with the plan sponsor to gauge what information about the investment should be conveyed to participants.  If the plan sponsor wants to provide more detailed statements than is customary, then the adviser and plan sponsor must determine whether the recordkeeper can accommodate that need, says Craig Adamson, president of Adamson Financial Planning. Advisers should make sponsors aware of the potential for increased costs of more detailed recordkeeping, he adds.

Unlike other investments, guaranteed solutions require more data to be transferred, so recordkeeping connectivity must be in place, says Sri Reddy, senior vice ­president of institutional income at Prudential Retirement­ and ­treasurer/board member of the Retirement Income Industry Association (RIIA). He suggests choosing a ­widely-accepted market solution so portability is easier. “There [are] always new solutions, but you should look for broadly-used products so it’s easier to move from recordkeeper to recordkeeper,” he says.

Adamson agrees: “I would think that, practically speaking … that would seem to be a backward move, if the program isn’t easily accessible or adoptable if a plan sponsor wants to make a change.”

2) Portability for Participants.In addition to plan sponsors having portability to move recordkeepers, it is important that participants have portability within their retirement plan. Advisers should consider whether participants would surrender a benefit if they exited their retirement income solution to move to another plan investment or if the participant exits the plan, Lee says.

“In terms of evaluating income options, advisers and plan sponsors need to work with the investment manager to understand the product,” Lee says. “There’s no shortcut. We would recommend asking specific questions on likely scenarios like, ‘What happens if a participant leaves the company?’ That can highlight the important tradeoffs the plan faces.”

Adamson adds, “If a client chooses one of these income options and something happens and it’s not a good fit for them, can they unwind it? Can they get out of it without incurring a penalty?”

3) Investment Provider’s Reputation.Adamson says it is important to research the investment manager providing the income option to ensure that which the plan sponsor is considering is reputable. Advisers and plan sponsors must ask themselves whether they believe the chosen provider will be able to honor the commitments it promotes as a solution. If the retirement income solution is not an annuity, will the provider be able to make payments for the next 20, 30, 40 or more years?  Is the money guaranteed, and if so, how?

 “It might have a great product,” Adamson says of lesser-established providers, “but is that the company your participants or retirees can rely on?”

Financial stability and the company’s length of time in the marketplace are important factors to research. After all, if a service provider decides it can no longer make money from a program that has been selected as a retirement plan investment, major problems can arise for employees.

 “If you’re a participant [who’s] five years from retirement, and now you’re not going to be able to be part of this program, what do you do?” Adamson says.

 He suggests researching the company’s Comdex rating, which is a composite index based on the ratings received by a company from the ratings services. It is also important to research whether the company has been sued, if it is publicly traded, has high executive turnover and is meeting its ratings forecasts.

 A plan sponsor performing due diligence should be asking these questions to the adviser, and the adviser should be able to supply this information about the provider, Adamson says.

4) How the Product Mitigates Risk.  Advisers should always keep in mind participants’ funding and savings risks. For many participants, their retirement fund may be the biggest sum of money they have ever had, so it creates a perception that they have saved enough, Lee says.

“Participants don’t think about how account balances translate into spendable monthly income,” he says. “They underestimate longevity, and that leads to poor or insufficient savings behavior.”

Advisers must also keep in mind market risks. “When you think about recent market returns, they’ve been extremely volatile. Many participants at or near retirement have lost significant portions of their wealth, and they don’t have the earnings power or time horizon to make up those losses,” Lee says.  

When choosing a retirement income product, he says advisers must consider all of these risks and question whether the product gives participants what they are asking for—a steady stream of income. Advisers must also ask themselves what risks the added solution will directly reduce for the participant.

 “You really have to peel back the layers of the onion to figure out what you’re going to offer and why you’re going to offer it,” Adamson says.

He suggests advisers put themselves in the shoes of participants and sponsors: “What would scare you? What would make you excited? What would your parents think [about this option]?”

Advisers should ask themselves, from a plan sponsor standpoint, “How much of a hassle will this option be? Will people participate in this?”

5) Psychological Barriers. When considering a retirement income option, it is crucial to make it easy for participants to overcome the psychological barriers to adoption, Lee says.

“For example, target-date funds have become exceptionally popular investment solutions because they provide participants with an easy way to get the diversification they know they need,” Lee says. “Placing an investment vehicle designed to deliver a guaranteed stream of income beginning at retirement inside a target-date fund enables advisers and plan sponsors to provide participants with what they want and need in a package they are already comfortable with.”

Fixed annuities, Reddy says, have been available for years but continue to have a low rate of use because people dislike the idea of their money being locked up without the availability to access it.

As an adviser, it is always important to be part of the conversation between plan sponsors and participants, Adamson says. He suggests plan advisers lay out the facts clearly and educate the plan sponsor. Then, the plan adviser can offer one-on-one meetings with participants and explain how the product works so they have peace of mind.

 “Try to work through some of this stuff instead of allowing the rumor mill to overtake the message,” Adamson says, adding that if participants are clueless about a product, they may rely on their co-workers to tell them about it.

“From a hesitancy standpoint, I think it’s [solved] by talking to people and understanding where they’re coming from,” Adamson says. “Any time you change something on a plan, it’s all about communicating the change: ‘Here’s why your employer is adding this benefit. Here’s how we think it will help you.’”