Continued Growth

Art by Julie Benbassat

Successful saving for retirement through a workplace defined contribution (DC) plan consists of two broad phases: First, the worker salts away as much of his earnings as possible and invests for prudent growth. Second, when work is done, he needs to carefully draw the funds down so as to enjoy life in retirement, but still invest for income and growth while managing the tax angles and holding some aside to leave to the kids.

In the first phase, the instructions are straightforward and pretty much the same for all participants. Accordingly, sponsors have been willing to make accumulation-phase choices for working participants through qualified default investment alternatives (QDIAs)—these days, primarily diversified target-date funds (TDFs).

But what about the retirement part? Participants’ paths quickly diverge and soon become complicated, depending on what assets they own outside the plan or what pension benefits they might be entitled to. Defaults that switch from a TDF to another allocation for the retirement stage—hybrid, or dynamic, QDIAs—have been around for a few years, but most sponsors are unwilling to commit participants to a structured withdrawal. This is coming, though, through defaults into managed accounts or annuities. Yet to be determined, however, are reasonable levels of costs and what role plan advisers will have in a world of retirement defaults.

The lack of a retirement income framework is understandable: 401(k) plans are not quite 40 years old, and few of today’s retirement-age workers have spent their career participating in one. Moreover, as sponsors have only recently started to encourage retiring participants to remain in their plan post-employment, there has been no need for any retirement income solutions, much less a sponsor-chosen default.

Providers are now developing such default structures in two primary dimensions: first, relatively simple guaranteed-income products such as immediate and deferred annuities, and second, more complex managed accounts. The latter provide asset allocation advice tailored to participants’ circumstances, as well as important collateral benefits, including drawdown strategies and guidance for selecting the right time and location for retirement and best timing for drawing Social Security benefits.

“We talked to three big recordkeepers about dynamic QDIAs,” says Greg Adams, a consultant at Fiduciary Investment Advisors in Windsor, Connecticut. “One has laid its managed account product over a TDF, with a transition trigger based on assets, age or vested status in outside benefits. Another firm had no interest in them.

“The third is more enthusiastic,” he continues. “It built a white-glove transition service around its QDIA. But what really stood out was that, when participants hit the transition trigger, they get a call from a Series 65 representative to tell them what’s happening. This recordkeeper feels that its managed account service can be a real value-add and that having an adviser reach out to provide investing and general financial advice will get the participants more engaged.”

State Street Global Advisors (SSGA) has developed two dynamic QDIA structures, says Greg Porteous, head of the firm’s defined contribution intermediary group, in Boston. One structure is managed accounts. “We looked at where the largest balances are, and where people need the most customization in portfolio allocation, and built a program that gives participants an off-the-shelf TDF until age 55; then it defaults them into a managed account, where we partner with [recordkeeping firm] Empower Retirement. It’s all index funds, and Empower’s participant data is fed into a Morningstar managed account engine for personalized advice.”

Porteous also cites a pending guaranteed-income QDIA, where participants invest in SSGA’s TDFs until age 55, at which point a portion of assets—25%, up to $130,000—is invested in long-duration fixed income. When the person turns 65, those proceeds purchase a qualified longevity annuity contract (QLAC). “From age 65 to 80, the participant can draw down from the 75% of assets in [his] account and then receives lifetime income from the annuity,” Porteus explains. Building the portfolio of fixed-income assets over time to purchase the annuity is akin to dollar-cost averaging and helps reduce the point-in-time risk of buying the annuity.

Another structure under consideration is what Jason Shapiro, director of investments at consultants Willis Towers Watson, in New York City, calls “unwrapped” target-date funds. “Actually, these aren’t new and have long been used in the small- and midsize-plan market in the form of model portfolios. Every recordkeeper says its platform can handle them.

“Sponsors would have the flexibility of defaulting into an annuity product, a deferred annuity and a diversified managed payout fund, and those could be part of the model portfolio created for people near or in retirement,” Shapiro says.

Advisers are split on what sort of choices—if any—would make the best retirement defaults. “A managed account is not where we see the value,” says Greg Hobson, a partner and senior financial adviser at Greenspring Advisors in Towson, Maryland. “And an annuity solution could be great for participants, but we’re worried about not causing harm to people who might need access to their funds.”

“Most plan sponsors acknowledge that a managed account will lead to a better outcome, but they’re worried about the incremental cost,” observes Vince Morris, head of Resources Investment Advisors, in Overland Park, Kansas.

Proof that the concept works would be a help. “When we have data to show that this makes an impact on people’s lives, the cost side will become less of an issue,” Morris says.

According to Adams, “It’s going to take decades before we know whether a managed account creates value for participants. Until we see how well this works, putting it in as a default may be presumptuous.”

“I’d like to be able to put the decision in a box through a default,” says Hobson, “but it’s a time when people need individual counseling more than they need plan sponsors making decisions for them.”

Although having a retirement income default would institutionalize some decisions, advisers seem unworried about being crowded out of the process. In the case of Empower’s managed account offering, says Porteous, “It incorporates the adviser more than an off-the-shelf TDF does. [For participants] age 55, the adviser is guiding asset allocation and selecting the individual investment options based on the makeup of the participants. That’s a role that is more active—and for longer—than just selecting a TDF and letting it ride.”

Ten years out, the dynamic QDIA’s record of participant outcomes will speak for itself. Moreover, “We’ll get better at simplifying these choices,” says Martha Tejara, head of consultants Tejara & Associates in Bainbridge Island, Washington. “That’s what we did with TDFs, and it’s what we have to do for handling 401(k) retirement. The solution can be sophisticated—but simplified so participants aren’t terrified of it.

“Look at how the Department of Labor [DOL] requires disclosure of the different distribution options for DC plans,” she says. “It’s so complicated that many employees choose what they think is simplest—just cashing out—when in fact that is the most complicated decision they can make.”

“We’re all looking for the absolute best solution that considers every individual and what each of them needs,” says Shapiro. “In the meantime, that thinking has stopped the adoption of a lot of good things, for at least some of the population. To paraphrase Voltaire, ‘We can’t let the best be the enemy of the good.’”