Companies that sponsor defined contribution (DC) retirement plans such as 401(k) plans are being asked by our elected representatives to add income solutions to their plans. Incorporating income solutions, including annuities and other guaranteed income products, within a DC plan provides increased security to participants, improves human resource (HR) management capabilities for sponsors, and provides societal benefit to America.
The Institutional Retirement Income Council (IRIC) recently released a white paper in which it demonstrates the broad and comprehensive benefits to participants, sponsors and to society attained through institutional income solutions.
Higher levels of retirement security
Participants in plans that emphasize retirement income are the primary beneficiaries of these solutions.
By having an income-oriented perspective, participants with income solutions within their DC plan, especially guaranteed solutions, meaning the amount participants receive won’t ever decrease, enjoy a much higher level of retirement security than do participants who view their retirement plan from an accumulation perspective. In its paper, IRIC highlights several advantages retirement income solutions offer participants including:
· Participants with guaranteed solutions can maintain a higher exposure to equities and therefore are less prone to sell their riskier assets in the event of a market correction and thus will recover more quickly as the market rebounds.
· Participants who “self-insure” their retirement have less money and less security than those who receive guaranteed income.
· Participants who understand the income they will generate from their retirement nest egg are more likely to have a better understanding of their financial security versus those who simply see their DC plan balance as an accumulation retirement benefit. These participants with an income orientation are also more likely to have a better retirement plan in place and are more in-tune to the risks they will face in retirement.
· Certainty around the amount of income in retirement is part of the financial wellness solutions participants seek during their employment.
· Participants who make decisions regarding retirement income in their 50s and early 60s have less risk due to cognitive decline than participants who manage their own retirement through their 70s and 80s.
· By investing in a deferred annuity, near retirees enhance their investments and ameliorate many of the risks that impede retirement security for participants who do not have access to annuities and guarantees.
· DC plans are able to negotiate lower cost annuities for their participants thereby affording their participants retirement income that can add up to several hundreds of thousands of dollars in income and/or residual retirement balances.
Sponsors also benefit
While plan participants are the primary beneficiaries and recipients of retirement security for those whose employers have added retirement income as a feature to their plan design and investment menu, plan sponsors can also benefit. With that said, a plan sponsor should only add a retirement income product or solution if it benefits both the employer and participant. In other words, like any other addition to a benefit plan, employers need to analyze the effect that it will have on employee morale; productivity; attractiveness of the organization as a career choice for new, highly talented employees; retention of current employees; and helping the organization manage the cost of their most precious resource, their human resources.
Ideally, retirement income should be offered by employers as part of a retirement plan and a feature to help employees build a diversified nest egg for their retirement.
For more than a decade, our policy makers have provided favorable legislation, facilitating regulations and incentive policies, all to promote the use of guaranteed lifetime income in DC plans. They have several goals in mind when supporting guaranteed income in our retirement system:
· Keep seniors from de-cumulating assets too quickly so that as retirees age they are less likely to fall below the poverty line and can maintain their standard of living.
· Keep the decision to offer and adopt guaranteed income under the fiduciary standards of ERISA where income options are always required to be made in the participant’s best interest.
· Stimulate even and consistent consumption from an important and growing sector of our economy; seniors, so that economic activity remains at robust levels.
The benefits to participants, sponsors and society are not insignificant. The adoption of this new paradigm will change how we view and appreciate our evolving retirement system. As traditional pension plans continue to fade away, and the solvency problems of our Social Security system go untouched, our DC system will be viewed by many as delivering real funded security through the use of guaranteed products to decumulate retirement balances. Retirement income generated from our DC system is a win for participants, sponsors and society in general as our DC system can deliver additional financial security to aging Americans.
Bob Melia retired at the end of 2021 as executive director of the Institutional Retirement Income Council, a nonprofit, membership based organization of retirement industry advisers.
Ahmet Kamil is director, defined contribution product lead at Pacific Life, which sells annuities.
The views expressed here are those of the authors and are subject to change over time. They do not necessarily reflect Pacific Life’s views on any of the topics discussed.