Sizing Up
Whether the discussion is positive or negative, in-plan guaranteed income options appear to be among the most talked-about products in the retirement plan industry lately, particularly since the market downturn illustrated the downside risk of retirement savings and underscored the need to make savings last. Two of the first products on the market were Prudential’s IncomeFlex suite of products and John Hancock’s Guaranteed Income for Life offering (see “The Inside Story,” PLANADVISER, September-October 2008). Some providers are hesitating, but others have followed, most recently Mutual of Omaha and Great-West.
So far, the products offer different iterations of the same idea, using what is often called a guaranteed minimum withdrawal benefit (GMWB), which allows participants to protect against downside risk while continuing to invest in the market for upside potential.
The take-up rate of guaranteed income products has been picking up slowly but steadily. As of May, Prudential reported that 260 plans, or about 10% to 15% of the clients the firm targeted with the product, have adopted IncomeFlex, and about half of all new recordkeeping clients are taking up the product, but the firm would not comment about participant use of the product.
Despite slightly more acceptance of guaranteed income products, there are still many critics who question the fees and portability of the products—let alone how to explain the complicated products to participants. Proponents of the products say insuring retirement savings is worth it, at least at some plans and for some participants.
The issue of providing a guarantee also has caught the eye of Washington. Earlier this year, the Department of Labor (DoL) put out a request for information to gather comments about whether and how the government should be promoting annuities and other lifetime income products in retirement plans. The comment period ended in May, and the DoL received 700 comments.
As more and more products roll out, it will become increasingly important for advisers to interpret the differences among them. Dorann Cafaro, General Partner at Cafaro Greenleaf in Little Silver, New Jersey, says it is like being back in the old days of the target-date funds, as most plans do not even have the option of a guaranteed income fund in their plan—and, if they do, they might have only one choice. Yet, despite the lack of options, from a fiduciary standpoint, advisers still have to determine whether something is appropriate for participants, she says.
Here are a few areas sources suggest advisers look at when evaluating and comparing guaranteed income products:
Insurer risk. Like any insurance product, advisers should evaluate the quality of the insurance company behind the guarantees. The financial stability of the insurance company is the key issue when it comes to fiduciary responsibility, according to Fred Reish, Managing Director and Partner of the Los Angeles-based law firm Reish & Reicher. “However, fiduciaries are not required to have a crystal ball to the future. That is, they do not need to make a decision about whether the insurance company will be there 30 to 40 years down the line. Instead, plan sponsors should look to evidence, like credit ratings and financial ratings, to make sure that the insurance companies are financially secure at this time,” Reish says.
Some providers are pushing for a multi-insured solution, which Robyn Credico, defined contribution consultant at Towers Watson, says could help fiduciaries diversify their risk. However, there seem to be collaboration challenges among insurance companies to create one. “I hear a lot of talk about this and, so far, no reality,” Credico says.
Portability and flexibility. One drawback to these products is that many recordkeepers—except for the insurance companies offering the products and some larger recordkeepers—do not allow them on their platforms. Advisers should find out what happens if a plan decides to switch recordkeepers and the product is not available on the new platform (normally participants might be able to roll their balances over to an IRA).
Advisers also should consider what happens when the participant wants to leave the plan or investment. Can participants roll what they have accumulated in the investments over to an IRA? Can they opt out of the product within a certain time period? “You have to understand how liquid these solutions are,” notes Credico.
Fees. A big plus for these in-plan products is the institutional price; some sources say they are a better deal than a traditional annuity.
Like traditional annuities, advisers can look at what other high-quality providers are charging in order to “get a good sense of whether or not the cost is reasonable,” notes Reish. However, one thing to watch out for is how the providers charge the fee, notes Bill Heestand, Principal at The Heestand Company, a member firm of National Retirement Partners. For instance, some providers charge against the benefit base, not the market value. “It’s not really apples to apples to say one is priced at 50 [basis points] and one’s at 90,” he says.
A part of looking at fees also is considering the underlying investments you are paying for, says Credico. Some products might be heavy on index funds to make it cheaper, so you have to make sure you are comparing apples to apples, she adds.
Step-up, withdrawal, and guarantee features. Other product features can vary among providers, such as how the benefit base increases (called “step-up” by some providers) and when the benefit increases (often once a year). Furthermore, advisers should look at what percentage of the benefit base the provider will pay at what age and other bells and whistles, such as spousal guarantees. (Tools to evaluate different features are available on the Web site of Institutional Retirement Income Council, www.iricouncil.org.)
Participants. Participant demographics are key to consider before even deciding to implement these products, but the industry is still figuring out who is the best fit for these. For instance, Credico says the product is more beneficial for an older workforce, as opposed to a workforce with no one nearing retirement. She also notes the products might not fit for a workforce that does not need to annuitize because they receive enough annuitization from Social Security and use their 401(k) savings as disposable income.
Even if all the features seem to fit well for participants, the hardest challenge might be educating them. “The biggest problem without question is explaining it to the average person,” notes John Barry, a registered Principal at JMB Wealth Management Inc. in Torrance, California. The education materials a plan provider offers might even be an added bonus to consider when evaluating products.
Despite the challenges of explaining, Barry has recommended the use of guaranteed income products in some situations by almost creating “a defined benefit plan in a DC scenario.” Likewise, Heestand says guaranteed income products can be helpful to protect against sequence of return risk—and it might be safer to have them than not have them. “You can’t possibly know what everybody’s temperament is, so you better have a full spectrum of investment options,” he says.