While consulting for a health care company recently, Steve Vernon, president of Rest-of-Life Communications, a retirement education consulting firm, met a woman in her late 50s who was highly motivated to help her company start researching a menu of retirement income options ASAP.
“I’ve been saving for about 25 years; I’ve got that part down,” she told him. “But I’m really scared about what to do in the payout phase.”
Retirement plans exist to provide earnings streams to retirees, but knowing how to “pensionize” retirement savings is largely a foreign concept to most workers. Ever since American companies began shifting from traditional pension plans to defined contribution plans three decades ago, the plans’ focus has been on the accumulation side of the process.
Now retirement day has arrived or is approaching for millions of baby boomers, and very little attention has gone into how plan participants can generate a reliable lifetime income stream from those account balances. Just as the shift to defined contribution plans required appropriate investment options and education about how to choose them, is now the time for plan sponsors to offer a retirement income menu and education on managing the de-accumulation phase?
Steve Vernon, who is also a member of the Institutional Retirement Income Council, has no doubt the answer is yes. (His white paper, “The Retirement Income Menu: An Idea Whose Time Has Come,” is online.) He points out that few people have the time and skills to assess how best to invest and draw down their account balances. Yet decisions made at this juncture will affect employees’ ability to sustain themselves financially for the rest of their lives.
“It’s a natural and valuable follow-on for companies who value their employees,” he asserts. “There’s so much confusion on ways to generate income. Employees have come to trust employers on the investment side, so employers are a natural for this.”
Surveys have shown how eager employees are for help in this area; 91 percent reported they’d find valuable a statement of how much retirement income their accounts could generate, according to the 2011 Retirement Confidence Survey of the Employee Benefit Research Institute. More than half of those surveyed in a 2010 Society of Actuaries’ report said they were concerned about outliving their assets, while 39 percent said they planned to draw down their savings “as needed” to cover expenses—but had no set plan to do that.
Giving employees a well-designed retirement income menu is an obvious win-win for employees and employers, according to Vernon.
“Companies that value smart, older workers will be the first to do this, even though they’re not legally required to,” he asserts. “Companies know it’s on their employees’ minds, and this service would help employees feel better, be more productive, and less fearful of retiring—which clogs the promotion channel.”
The Retirement Income Menu: A Sampling
In his white paper for the IRIC, Vernon looks at a variety of possible retirement income methods plan sponsors could include (as well as a lump sum payout and/or rollover option for those who don’t want the retirement income menu). He recommends a plan have five or six options, along with a “robust education” effort to help employees assess the pros and cons of each method, and how they might work in combination (For example, a retiree might use part of the account balance to purchase an annuity to address longevity risk, and invest and draw down the account’s remaining balance as a way to retain access to money for emergencies.) Making modeling tools available that show employees how much retirement income could be generated by each method will also aid in the decision making.
Among possible retirement income menu choices:
• Traditional fixed annuities. Many insurance companies offer these, and services such as Hueler’s Income Solutions provide a web-based bidding service among a panel of selected insurance companies.
• Managed payout funds Several of the largest mutual fund companies--including Fidelity, Vanguard, and Schwab--offer these funds; they pay interest, dividends and principal over specified periods.
• Guaranteed Minimum Withdrawal Benefits (GMWBs) Insurance companies such as Prudential, Hartford and Diversfied/America provide this product, which offers a combination of invested assets with a guarantee of lifetime retirement income.
• Immediate variable annuities Aerican General Life offers this type of annuity, where the monthly benefit is adjusted to reflect investment performance of underlying Vanguard mutual funds.
• Hybrid products Some financial institutions offer a hybrid option that combines managed payouts with longevity insurance (annuities that begin at an advanced age, such as 80 or 85).
Waiting on “Regulatory Guidance:” Don’t Let the Perfect Be the Enemy of the Good
Vernon also offers a strategy for plan sponsors reluctant to proceed without more ERISA guidance on such issues as protection from participant losses—especially the thorny issue of employees who leave without making an election for retirement income from the menu.
Very simply, it involves a fund that satisfies the Department of Labor’s requirements for a Qualified Default Investment Alternative with the Required Minimum Distribution under the IRS code.
The bottom line: there are solutions to concerns plan sponsors have about implementing retirement income menus, and there is an urgent need to begin at least educating employees about what they’ll need to consider when the time comes to turn their retirement savings into income. There are a host of good reasons for employers to begin offering a retirement income menu, but it is also, Vernon sums up, “the right thing to do for your people.”