Glenn Dial

PA: Can you tell us about guaranteed products in a retirement plan?

Dial: A guaranteed investment is essentially insurance or, more specifically, an annuity. That’s the only way to eliminate longevity risk, the risk of outliving your income.

Some target-date fund providers say that if you stay in their funds past retirement, then there’s a 95% chance you won’t outlive your assets. The problem with that assertion is that the remaining 5% poses a significant risk. Framed another way, it means that in one out of every 20 years, retirees won’t be able to pay their bills. When it comes to retirement income, reliability is far more important than probability. Nothing should be left to chance.

At Allianz Global Investors, we’re looking at how to get a more predictable stream of income—whether that’s in-plan or out-of-plan. And getting the structure right is challenging. One reason is the existing infrastructure. The individual retirement account (IRA) rollover market is already well-established, so new entrants will struggle to achieve scale. In a defined contribution plan, mutual funds, including target-date funds, are set up so that when plan participants reach retirement, they withdraw their accumulated savings and purchase some sort of retirement-income investment.

But that transition leaves investors exposed to interest-rate fluctuations, or transition risk. So the question is, how do you manage that transition risk with an out-of-plan investment option? In-plan, you’ve got the ability to guarantee a portion of your income before age 65. But there are challenges in terms of portability and cost.

PA: Can you explain how transition risk can hurt plan participants?

Dial: Sure. I’ll give you a hypothetical example. Let’s say a company decided to mandate that its employees buy an immediate annuity when they retire. But then interest rates fell sharply. So, if you retired today with the same amount of money as plan participants did five years ago, then the amount of guaranteed income you could buy as part of your policy would be significantly lower. At Allianz Global Investors, we’re able to tap our in-house risk management capabilities to help plans manage transition risk and achieve a stable income stream for their participants.

PA: Do you see any other viable out-of-plan options for retirement savers?

Dial: There are annuity exchanges that sit outside retirement plans. And there’s also the traditional IRA rollover market. Roughly half of all plan participants are being served by advisers outside their plan when they retire. So when I think about out-of-plan solutions, I immediately think of the so-called delegators, plan participants who are defaulted into qualified default investment alternatives (QDIAs). They tend not to get a lot of attention from advisers because they have lower account balances.

For these folks, Social Security is going to make up the bulk of their retirement income. Maybe they have $100,000 to $150,000 in their 401(k). What are they going to do with it? With out-of-plan options, retirees should look at their expenses and annuitize a portion of their savings to cover those expenses, while putting the rest in an emergency fund. In terms of the income product itself, it can be a ’40 Act mutual fund with an insurance wrapper or a managed payout fund.

PA: Can you highlight the pros and cons of retirement-income products?

Dial: With an in-plan solution, the biggest pro is that you can get guaranteed income, locking in a minimum payout. This will cushion the blow if there’s a steep market drop. However, the downside is the lack of portability and pricing.

With out-of-plan solutions, the biggest benefit is flexibility. Financially speaking, the day you retire is the biggest inflection point of your life. We don’t actually know how much income we’re going to need. We don’t know if we’re going to have health issues or problems with our coverage. From an out-of-plan solution, you’re free to do whatever you want to generate retirement income. You’ve got options.

The biggest drawback of out-of-plan solutions is that you have to manage transition risk. If you’re going to buy an annuity, then you have to understand the interest-rate environment and prevailing market conditions when you cash out of the retirement plan. There’s sequencing risk—the risk of retiring in a down market—on the front end and transition risk on the back end.

The retirement income conversation needs to include more than just products, said Glenn Dial, managing director and head of U.S. retirement at Allianz Global Investors, speaking on a panel about the topic.

Part of that conversation is about the relationship between retirement-income strategies and target-date funds. Some target-date funds—specifically “through” funds—were meant to be a stand-alone retirement-income investment and provide systematic withdrawals. Therefore, it makes sense that plan advisers “define the retirement-income solution before picking the type of target-date fund—to make sure they line up and they’re not contradicting each other.”

Ultimately, the answer may be a strategy to help participants maximize their savings. For example, he said, multiple studies have suggested that the longer you can defer Social Security, the better off you’ll be from an income standpoint. If plan participants can use their 401(k) plan as a bridge of sorts, the extra income from Social Security is on top of their investments, Dial noted.