Make It Last

Art by Linda Yan

When fortunate enough to receive large sums of money, many people have trouble coping. Jay Zagorsky, an economist at Boston University, found in his 2012 research that, among people in their 20s, 30s and 40s fortunate enough to claim an inheritance, about half the money was spent or lost in short order. Other academic research indicates that winning a lottery is not a ticket to Easy Street—winners save only a slim fraction of their windfall and, within a few years, face an elevated chance of bankruptcy.

While receiving a lump sum at retirement might not hold the same surprise as a golden ticket, people still have trouble managing the money: A MetLife study in 2016 among about 1,000 adults receiving lump sums from retirement plans or lawsuit settlements found that, on average, one in five had depleted the funds within 5.5 years. Thus, to convert their retirement savings into a stream of income that goes the distance, retiring participants clearly need a retirement income mindset, as well as investment vehicles that meet their individual risk profile.

“Past efforts on withdrawals of retirement income didn’t get traction,” notes Dave Gray, head of workplace offerings at Fidelity Investments in Boston. “But now the stars are aligned—with a growing number of retirees, interest from sponsors and the industry, and even the legislative environment driving interest in retirement income benefits through 401(k) plans.”

“In our latest survey of defined contribution [DC] participants, we asked participants how much they would need to save for an adequate retirement, and the median answer was $1.7 million,” observes Nathan Voris, managing director of business strategy at Schwab Retirement Plan Services in Richfield, Ohio. “We think that’s a pretty good goal to set.”

Few people have achieved that level. Fidelity reports that, among its 30 million DC accounts, the average balance for those ages 60 through 69 came to $201,000. For employees in that age band with 10 years tenure at the same employer, the average was $357,200. Reconciling those balances with the average U.S. household income of about $62,000 in 2018, and the 20-to-30-year span of retirement likely for many Americans, illustrates the challenges of effective investment and conservative distribution.

About half the sponsors of large plans want participants to stay in their plan after retirement, and only 6% say they want them to leave, says Lorie Latham, senior DC strategist at T. Rowe Price Group in Baltimore. For plans with assets below $500 million, though, only 30% want participants to keep their money in the plan.

There are plenty of good reasons to keep retired employees invested. From the plan’s perspective, a larger asset base will sustain economies of scale. “For the last three years, there have been net outflows from DC plans—that has been masked by the bull market,” says Bob Melia, executive director of the Institutional Retirement Income Council, a group of consultants, advisers and providers. “That will only increase as more Baby Boomers retire.”

Participants have plenty of reasons to stay in as well: lower fees on investments than they might get in the retail market; Employee Retirement Income Security Act (ERISA) fiduciary oversight of their investment options; and products designed to generate and distribute income in retirement. Accordingly, sponsors and advisers are interested in learning the possibilities. “For some of my sponsor clients, having participants stay in the plan is their No. 1 priority,” says Martin Schmidt, head of MAS Advisors in Chicago.

Retirement income can be generated and doled out in many ways—some simple such as systematic payouts of a set amount or percentage of assets over time from a target-date fund (TDF) or other asset-allocation strategy. And others methods are sophisticated such as individually managed accounts or managed payout strategies that dynamically adjust to an age-appropriate portfolio based on changing market conditions.

The most complex involve guarantees from insurance companies—target-date funds with embedded deferred annuities or guaranteed minimum withdrawal benefits. United Technologies Corp., as its default for new employees, offers a TDF with an integrated lifetime income option.

Another guaranteed contender is fixed annuities, where a retiree turns over a block of retirement assets in exchange for a guaranteed stream of monthly payments for life. Recent passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act will likely promote the role of guaranteed products, as it provides a safe harbor for the annuity choices sponsors offer in-plan, given that the sponsor follows credit-quality guidelines. Moreover, participants may move annuities to other employers’ 401(k) plans or to individual retirement accounts (IRAs) without incurring fees and surrender charges.

In the current capital markets, any retirement strategy faces a Catch-22. Investing in fixed income conservatively, or even aggressively, earns minimal returns. Equities have soared in recent years but present significant risks of principal drawdowns.

To benchmark an annuity option, PLANADVISER reached out to Kelli Hueler, head of Hueler Companies in Eden Prairie, Minnesota. Her organization runs Income Solutions, which describes itself as an “independent, institutional annuity platform offered to defined contribution plans,” for the most part as a service outside of the plan. As of late this past December, institutionally priced annuities promised monthly payments adding up to about 6.3% annually of the contract value for a single-life annuity and, for a joint and survivor annuity, about 10% less in dollar terms.

Thus, for a hypothetical retiree with a 401(k) balance of $500,000, a single-life contract would have purchased life-long distributions of about $31,500 per year.

Retirement-specific options that leave participants with ownership of their assets show similar low returns. The J.P. Morgan SmartSpending 2050 Fund is programmed to spend down assets to an expected maturity date of 2050. As of this past September, fixed income made up about 80% of the portfolio with the balance in equity. Fundholders choose their own rates of distribution, but, at the start of each year, J.P. Morgan Asset Management provides a target spending rate, which for 2019 came to 5.4%—$27,000 on a hypothetical $500,000 balance.

Fidelity’s Managed Retirement Income fund is also conservatively invested and is meant for those over 70; at the end of October, it held 22% in equities, and had earned a three-year annualized return of 5.0%—i.e., for a hypothetical annual income of $25,000.

Taking a longer view of the retirement income puzzle, consultants at Willis Towers Watson teamed up with researchers at the Georgetown University Center for Retirement Initiatives, developing 30-year retirement outcomes for five categories of income-generating options, documented in their paper “Generating and Protecting Retirement Income in Defined Contribution Plans.” Results varied widely as to income available and assets on hand, though a fixed annuity option provided a constant income. Considering the varying circumstances of participants, one choice does not dominate.

“There’s a lot of thinking about a retirement ‘tier’ of several choices for retirement income,” says Dana Hildebrandt, director of investments in the New York office of Willis Towers Watson. “Some sponsors will say, ‘We’re not implementing this, because no one has asked for it,’” she says. “But no one asked for target-date funds, and look how well they’ve turned out.”