Defined contribution plans have become the most popular employer-sponsored plans in the United States, with the Department of Labor reporting more than 88 million participants in one of these plans nationwide.
However, unlike the previous retirement status quo, the defined-benefit retirement plan, defined-contribution plans don’t provide participants with a steady retirement income; they help workers amass as much wealth as they can for retirement, but it’s up to those employees to devise a strategy for making it last throughout their retirement. Unfortunately, without retirement income education or plan options provided by their employer, it can be very hard for employees to reach a viable retirement income on their own.
Even with this growing need for retirement income planning, the employer mindset may not be shifting to keep up. MetLife’s 2012 Retirement Income Practices Study found that 91 percent of plan sponsors still focus mainly on retirement savings rather than retirement income, and while 97 percent of defined-contribution plans offer lump-sum distributions, just 45 percent offer systematic withdrawal payments and a mere 15 percent offer lifetime annuity payment options. By offering retirement income options in addition to a retirement plan, employers can stand out in the market, increase their attractiveness to recruits and up the benefit adequacy of their plans while providing an invaluable service to plan participants.
The Employer Role in Retirement Income Planning
Retirement income is one of the fastest-growing trends in retirement planning; 82 percent of middle-income Americans surveyed in the 2010 Wells Fargo Retirement Study agreed that employers should offer a lifetime income option in their retirement accounts. However, just 22,000 retirement plans currently offer guaranteed income solutions. While not all employers will have the resources to offer these types of in-plan options, retirement income planning should be addressed in some way to give employees a way to plan their finances during retirement.
As the plan sponsor, you will likely be assuming at least some fiduciary responsibility for the plan, so it’s important to make sure your decisions are in line with the best interests of your plan and its participants. While no current legislation extends to providing income options, the idea of legislation that would require plan sponsors to automatically provide income calculations on participant statements has been introduced in Congress—so employers who get ahead of this trend could get rid of the need to change their retirement plan administration in the future. However, some plan sponsors worry that if they model retirement income, employees may think that this amount is guaranteed rather than an estimate—that’s why it’s important to provide not only income products or projections, but also accompanying education on the subject of retirement income.
Retirement income options may come in the form of add-ons or companions to your existing retirement plan, helping the participant focus on making their savings last throughout the length of their retirement rather than simply building up as large of a nest egg as possible. These options are often offered as annuity products or systematic withdrawal strategies and come in many different forms, which will be explained later on. Implementing a successful retirement income strategy at your company can help you attract and retain top employees by offering a competitive retirement benefit, and it can also help companies transition employees to retirement rather than having employees work longer than they should because of retirement income fear. When employees work past retirement age, it creates fewer opportunities for in-company advancement for younger employees and may create an environment of stress for older employees who feel trapped in the workforce to earn a retirement income. By helping employees build a retirement income they can rely on prior to this stage, you can make sure both your company and the welfare of your employees benefit.
Retirement Income Considerations: From Education to In-plan Options
Although opening the retirement income conversation is something that may become essential for all employers soon enough, as of now employers may choose how involved they want to be with retirement income planning. The changes you make may be subtle, such as encouraging employees to think of their retirement funds in a different way through education, or they may be large structural changes to your retirement plan, such as offering retirement income options within the plan itself. Still other employers may choose to use out-of-the-plan options, providing employees with income options without assuming the fiduciary duty of keeping the product within their plan. Before choosing which option is best for you, make sure you’re clear on what each of them entails.
Education
For many employees, a retirement account is the largest asset they own, and, when viewed as a lump sum, such a large amount may seem inexhaustible. However, this number appears a lot less massive when explained as a monthly income. Participants have to learn how to turn this lump sum into an income stream for themselves, and without education that addresses translating an account balance into a monthly income, this can be almost impossible. In fact, a majority of the plan administrators surveyed in MetLife’s June 2012 Retirement Income Practices Study estimated that 25 percent or fewer of plan participants had even made an effort to project their retirement income.
This gap in employee education provides an opportunity for employers to step in—simply providing a retirement income projection for employees can make a huge difference in how they view their retirement. By setting a potential monthly income, employees are forced to ask themselves, “Can I really live off this?” Many participants choose a lump sum option out of fear that their needs will change in the future and they will need as much money as possible, but certain retirement income options also allow for this type of flexibility, which many employees remain unaware of. It’s important to address this and other common retirement income misconceptions—your education program should ultimately be centered on common questions that employees have regarding retirement income, such as:
How much can I afford to use each month?
What will inflation do to my potential income?
How should my investment strategy change after retirement?
What happens if the market goes down?
What if I outlive my current life expectancy?
What if I need long-term care?
And, most importantly…
Will I have enough?
By providing retirement income education to current employees, you can ensure that these employees start thinking about this crucial aspect of retirement planning before they enter retirement.
Plan Options
For employers who have the resources and the desire to go beyond providing education, there are also many options for offering retirement income planning through their existing retirement plan. These options are typically categorized according to two characteristics: whether they are in-plan or out-of-plan, and whether they are guaranteed or nonguaranteed.
As their names imply, in-plan options are products or strategies that are held within your existing retirement plan as a plan asset, or one which you as the employer controls or exercises discretion over. Out-of-plan products or strategies are those which allow participants to roll money out of the plan and then use these funds to buy a retirement income product or service from a third-party vendor. In this case, the employer can contribute by paying the fees to a third-party shopping service, allowing employees to easily view the market and choose the retirement income option that’s best for them. It’s important to note that in-plan options will generally carry a higher level of fiduciary responsibility for the employer, as assets remaining within the plan also remain under employer control.
Guaranteed and nonguaranteed retirement income options also stay true to their name in that guaranteed options are products, such as annuities, that provide a steady retirement income flow that is not subject to market risk. Nonguaranteed options, on the other hand, are often non-products, such as systematic withdrawal plans, and are subject to risk and therefore may provide fluctuating income payments.
Before selecting retirement income options, employers should consider the aspects of both in-plan and out-of-plan options as well as options that are guaranteed and non-guaranteed. Employers should also keep in mind during the selection process that they can offer more than one type of solution if they so choose. Certain retirement income options will prove better for certain employers based on their business structure and employee characteristics. Before making a retirement income decision, employers should be sure they have an understanding of what each type of option entails, as well as their benefits and downsides.
In-plan, guaranteed options
In-plan, guaranteed options may come in the form of fixed annuities or benefit add-ons to annuities that further guarantee the annuitant the right to withdraw a fixed percentage or value of income from the product. While products and options are frequently changing, current examples include deferred fixed annuities, guaranteed minimum income benefit annuities and guaranteed minimum withdrawal benefit annuities. These types of options provide the employee with a benefit similar to what those in a defined benefit plan would receive; employees are guaranteed a certain level of income because the products allow them to lock into an income payout upon purchase, regardless of market performance. Participants typically opt in 10 to 15 years before retirement, and additional contributions made leading up to retirement can increase the base amount of income the employee is guaranteed. In this case, the employer would have to select which annuity products to offer in the plan, which would up their fiduciary responsibility and liability.
Out-of-plan, guaranteed options
Similar to in-plan, nonguaranteed options, out-of-plan, nonguaranteed options allow retirees to set a plan for systematic withdrawals. However, retirees also have the option to use 401(k) distributions to invest in a product such as a managed payout fund or income replacement fund, which allow the participant to set a monthly retirement income that is paid out through a product, yet subject to market risk. While managed payout funds have a goal of paying out a percentage of earnings indefinitely, without touching the principal balance, income replacement funds are designed to be withdrawn from in a way that they will be exhausted by the stated end date of the fund. Each is subject to market risk, and for managed payout funds to avoid dipping into principal, they may have to take on more risk. However, managed payout funds are often attractive for those who want to preserve the principal of their account for their beneficiaries.
In-plan, nonguaranteed options
In-plan, nonguaranteed retirement income options don’t provide a guaranteed income payout to participants, so options don’t come in the form of an annuity product. Instead, this type of option helps participants define a set approach to spending their retirement account, rather than simply taking withdrawals whenever the participant feels they are needed. This may come in the form of a systematic withdrawal program, which means the participants can choose a specific payout amount to be received at predetermined intervals, or a discretionary investment advice program, in which an investment professional can give you a distribution model and provide withdrawal advice. The second option is usually available depending on whether the plan already offers a managed account option.
Out-of-plan, guaranteed options
Similar to in-plan, nonguaranteed options, out-of-plan, nonguaranteed options allow retirees to set a plan for systematic withdrawals. However, retirees also have the option to use 401(k) distributions to invest in a product such as a managed payout fund or income replacement fund, which allow the participant to set a monthly retirement income that is paid out through a product, yet subject to market risk. While managed payout funds have a goal of paying out a percentage of earnings indefinitely, without touching the principal balance, income replacement funds are designed to be withdrawn from in a way that they will be exhausted by the stated end date of the fund. Each is subject to market risk, and for managed payout funds to avoid dipping into principal, they may have to take on more risk. However, managed payout funds are often attractive for those who want to preserve the principal of their account for their beneficiaries.
Choosing a Retirement Income Offering
The previous overview of the many retirement income options available should help to give a background on which options may fit best with your business. Asking yourself the following questions can also help you gain a better idea of whether or not a retirement income option (and which retirement option) is right for you:
- Have you solicited participant input on retirement income options?
- Are you able to take on the fiduciary responsibility of an in-plan option?
- Do you want to offer employees the choice of more than one retirement income solution?
- What do you consider “guaranteed” income?
- Do you have the administrative resources to offer an in-plan option?
- Do you have the resources to offer comprehensive education on retirement income options?
- Will choosing a certain type of solution affect your ability to change plan administrators if you should want to?
- How much control do you want your employees to have over the retirement income solution? Do you want to give employees the option to opt in and opt out at any time?
- What would happen if you need to replace a plan administrator or insurance carrier?
- How will you select and monitor your choice of insurance carrier?
- How will you determine what a fair price is for your retirement income solution?
Discussing these and any other questions you may have with a financial and legal professional can help you determine the reality of offering a retirement income solution to your employees.
Conclusion
While the main focus of the retirement conversation is typically saving, spending in a managed way also needs to be addressed in order for retirement plan participants to have a financially stable retirement. It’s true that retirement income options can’t help those who haven’t saved enough in their accounts, but for those that have, this large nest egg can easily be squandered if participants don’t receive education on retirement income or retirement income solutions. A BlackRock survey found that 94 percent of employers feel responsible for helping workers prepare for retirement, but just 24 percent offer a retirement income solution. By taking advantage of this opportunity to differentiate, employers can play a key role in changing the retirement conversation and help themselves lower plan costs and retain top employees with retirement plans that go above and beyond.
