Retirement Income - The Distribution Deal

Are my employees adequately prepared for retirement? Few questions­ vex sponsors as much as that one, particularly what to do if participants lack tools they may need for the distribution phase, such as retirement-income products. “Clearly, in the corporate world, something like this is needed, whether inside or outside the plan,” says Robert Liberto, New York-based Senior Vice President at Segal Advisors.

Advisers can help employers deal with these complexities when deciding what to do about retirement-­income products.

Fiduciary Concerns

“Under prior law, a DC annuity had to be the ‘safest available.’ Congress amended that in the Pension Protection Act, and new regs were written,” says Stephen Utkus, Director of the Vanguard Center for Retirement Research. In October 2008, the U.S. Department of Labor (DoL) published final regs, including a safe harbor for selecting an annuity provider for defined contribution plans. “The problem is that, for most employers, there is a learning curve,” he says. For advisers, too: They may know a lot about evaluating investments, but many likely have little experience in evaluating credit quality of insurance products.

DoL officials “will tell you that they are a little surprised by the brouhaha created by this,” says Bob Toth, Principal at the Law Office of Robert J. Toth, Jr., LLC, in Fort Wayne, Indiana, “but it still is not clear to employers what standard should apply involving the insolvency risk. What nobody has any comfort in is that they do not want to effectively be guarantors. The DoL keeps saying, ‘No, we do not think the rule effectively says that you have to be a guarantor of the product.’ But that is the perception.”

“Right now there is a lot of confusion, but I do not think it is as tough as some people think,” Toth says. “The fiduciary standard in general is about prudence: They have to show that they did the due diligence at the time.”

Portability Lacking

Employers who want to change in-plan annuity providers cannot switch one company’s guarantee for another company’s guarantee, Utkus says. “Basically, you have to leave the old option in the plan,” he says. Since the original insurer’s guarantee cannot simply transfer to a second insurer, “You cannot map between insurance products. That has really hobbled the industry.” He points to Aon Hewitt statistics that 14% of 401(k) plans offer a traditional annuity form of payment, and that only 7% of 401(k) plans offer an insurance or annuity solution within the plan. The portability issue has put a damper on the idea to automatically enroll participants into a deferred annuity, he adds.

Portability remains a legitimately big issue for employers, Toth says. “The real problem is that, if you want to fire your insurance company, you have to carry the annuities in the plan until there is a distributable event,” he says. Advisers working with plans thinking about in-plan annuities can help by exploring with insurers how they can facilitate portability at the plan and participant level. “How will portability work? Everybody has a different solution,” he says.

Liberto thinks portability has seriously hampered annuities’ in-plan use. “SPARK (the Society of Professional Asset-Managers & Record Keepers) has worked with a number of providers to create a template for information transfer on annuities among recordkeepers that is close to being finalized. We may be a year away from saying, ‘It is fine, it is not an issue anymore,’” he says, “but, right now, consultants still have concerns about how it is going to work.”

Out-of-Plan vs. In-Plan

If retirement-income products have any momentum in the retirement plan context, it is outside of plans at distribution or retirement, Liberto says. Even then, he says, “I still do not think it is a lot.”

Plan sponsors can help ease fiduciary worries by electing to facilitate outside-the-plan access through a platform like that offered by the Hueler Companies, which allows people to buy institutionally priced annuities with their retirement assets. “When they go outside and use a firm that can offer low costs and give people multiple bids, that liability potential drops dramatically,” Liberto says. Participants likely get a better deal than they would in the retail market: A broker may charge 3% to 6% of a participant’s balance as a one-time fee to arrange an annuity, he says, while access to a marketplace like Hueler’s can come at a 1% fee. “It is a great deal, from a fee perspective,” he says. “It is a low-cost product.”

Product Issues

The industry’s attempts to deal with the biggest raps on these investments as products—inflexibility and high fees—continue. “The flexibility has increased tremendously,” Toth says. “When you talk about an annuity, everybody thinks about a fixed annuity. Annuities have changed a lot in the past 10 years. Oftentimes, people are able to make withdrawals on favorable terms and, ultimately, they can take the full amount out before they annuitize.”

So-called “living benefits” that offer people minimum guarantees on how much they get back are seeing huge takeup in the retail marketplace, Toth says. “The problem in the retirement market is that some of these products are very confusing; these products are really designed for high-net-worth individuals, who often will have a sophisticated financial planner to assist in understanding the policies’ complex terms,” he says. “The issue is how to simplify it enough to make it easier for the typical participant, who may not have access to the sort of advice as does a high-net-worth individual.”

Also, fees remain an issue. “The in-plan option can reduce a participant’s balance by 10% over a 10-year period,” says Randy Bachman, The Principal Financial Group’s Vice President, Income Solutions. “The payout is typically lower than an institutional income annuity.” Principal advocates people buying those annuities at retirement, versus utilizing in-plan annuity options.

Offering out-of-plan access to a retirement-income marketplace at institutional prices lets retiring participants avoid high fees, thinks Toth. “When everybody talks about these being pricey, I think they are talking about the retail commissions,” he says. “In the retirement-plan market, they are not high-commission investments.”

Getting Participants Interested

Plan sponsors might be reluctant to take on this conversation because of a lack of participant interest or demand. Utkus suggests advisers approach the education challenge by focusing on how to set up a portfolio for drawdown. A discussion of retirement-income products emerges naturally from that. “The product lineup is quite complex, but the basic tradeoff of managing your money on your own in retirement versus getting an annuity is relatively simple to present,” he says.

Most people do not want to make that tradeoff immediately when they retire, Utkus believes. “When they retire, what they want is to get a strategy to withdraw from their savings,” he says. “They want breathing room to decide. They use the first few years of their retirement to decide whether they need to annuitize, and how much.”

Fewer than 20% of participants have a written income plan, Bachman says. That gives advisers a big opportunity as people near retirement, he thinks. “Where the adviser comes into play is helping people put together a plan,” he says. “People need to answer the questions: How much do they need? What do they have? Is it going to last?”

In many cases, when an adviser helps a retiring participant put together a payout strategy, it could involve multiple products, Bachman says, including partial annuitization. Someone might annuitize part of his or her balance, keep part in an investment vehicle seeking returns, and keep some in a protective investment vehicle like a stable value fund. However they split up their balance, participants need a long-term plan as they approach retirement. “The term ‘retirement’ in today’s vernacular is not a single event,” he says. “It is a life stage that can go on for more than 30 years.”

—Judy Ward

Making Annuities Attractive

Advisers say investors would benefit from VA education

Most investors do not have a clear enough understanding of variable annuities (VAs) to appreciate the guaranteed income they potentially can provide, according to the results of a Sun Life Financial survey.

The Sun Life poll of nearly 500 advisers asked what most concerns their clients age 50 and older. Most advisers (72%) said these clients are concerned with having enough retirement income. Forty-two percent said clients are most concerned with accumulating enough money to retire comfortably. Thirty percent said longevity is their clients’ main concern. Only 15% said losing money in the stock market is their clients’ prime concern, and 5% named missing a market rally.

Plans Change

Most financial advisers (92%) said clients change their retirement income plans after retirement, generally to avoid running out of money or to meet nondiscretionary costs. Of those advisers who said clients change their plans, 43% said they do so to avoid outliving their income, and 34% said it is due to nondiscretionary expenditure needs, including unexpected health-care costs. Twenty-one percent said clients change their plans in order to have more money for discretionary expenditures.

Use of Variable Annuities

Eighty-three percent of advisers surveyed said that more than half (62%) of clients who could benefit from variable annuities do not actually own them; only 38% of clients who could benefit from variable annuities actually own them.

Nearly a third (27%) of advisers said their clients are “not very knowledgeable” or “not knowledgeable at all” about variable annuities. However, 21% said their clients are extremely knowledgeable, and 52% said they are somewhat knowledgeable. Investors who buy VAs generally allocate one-third (30%) of retirement funds to variable annuities.

Advisers said more of the clients who could benefit from VAs would invest in them if:

• Variable annuities had lower fees (43%)

• Clients received more education about variable annuities (38%)

• Variable annuities were easier to understand (38%)

• Variable annuities were a more commonly accepted investment (29%)

• Clients felt extraordinarily confident about the issuing company (28%)

• Advisers received better education about variable annuities (22%).

Adviser Experience Matters

Financial advisers with less than 10 years of experience are about twice as likely as more experienced advisers to think variable annuities involve high risk: 23% versus 13%. Most advisers (76%) are recommending VAs either as often, or more often, as they did before the recession.

VAs are one option in retirement income, however. The survey reiterated previous research that shows how older investors are looking for retirement income solutions (see “Focal Point,” page 22).

—Nicole Bliman