There has been an enormous amount of discussion in recent months about helping DC participants create a lifetime income stream from their DC savings. At the end of the day, though, all of this discussion and industry product innovation has yet to result in any significant change in how participants implement retirement income strategies during the accumulation phase.
The title of a recent Baron’s
article, “Create Your Own Pension Plan,”
(subscription required) speaks in many ways to the core challenge: participants being their own pension managers. Like it or not, self-directed DC plans are, essentially, accumulation-type programs ill suited to replace conventional pension plans.
It may be best to accept the fact that DC plans are accumulation vehicles. The goals should be to maximize savings and to ensure that the participant is in the optimal position to purchase an annuity when that time comes. That is, if that is the best alternative for the participant at retirement.
The reason traditional pension plans work as well as they do is because the employer and its advisors “create” a pension plan, behind the scenes, for employees. Shifting the responsibility to save, invest and annuitize away from employers to employees lies at the heart of many of the challenges DC investors face. The vast majority of participants are in no position to understand all the vicissitudes of funding their retirement. It is difficult, if not impossible, for most of them, on their own, to make a well thought out decision on how to position their assets for a lifetime, either during the accumulation phase or at their retirement date.
You Can’t Take it With You
Given the fact that the typical American worker now stays at a job an average of 4.6 years
, the issue of portability is a significant hurdle to overcome. There are many challenges with matching up the different asset allocation programs across different DC plans. This complex situation would be further complicated by trying to match up lifelong investment programs involving some sort of guarantee from an insurance company.
The issue of portability seems to be a nearly insolvable challenge without government regulation. Few, however, want that to happen, hesitant to step on the slippery slope toward increasing the government’s role in the private retirement system.
The challenge with “creating your own pension plan” is that there are so many variances in individual situations when it comes to knowing what to do with one’s nest egg at retirement. Just as DC investors have demonstrated the need for clear and direct advice on how to utilize a TDF or managed account, so too they need solid direction regarding retirement income. However, that direction must be tailored to each individual’s situation.
It can be argued that every DC investor ought to save the maximum amount allowed by law and invest in a prepackaged, risk-appropriate asset allocation program. It is hard to imagine how anyone would respond adversely to that advice — the worst possible outcome would be an excessively large retirement nest egg, a complaint that, it’s safe to say, is rarely heard.
A DC investor who reaches the at-retirement stage is in the “retirement red zone” — Prudential’s catchphrase for that period of time when retirees are hit with all the factors affecting income planning in retirement: unknown longevity, health care costs, market uncertainty, inflation, etc.
Given the multiplicity of vectors impinging on lifetime income strategies, retirees take one of three approaches: seek the professional help of a financial planner; do their own research and make their own plans; or simply wing it, hoping that they will not run out of income.
The Advisor’s Role
Through a growing understanding of behavioral finance and its application to DC plan design, DC plans continue to make progress when it comes to savings rates and the implementation of effective asset allocation programs. There is also an ongoing, active effort to deal with the “retirement red zone” challenge.
For plan advisors seeking to utilize one of these retirement income products or services during the accumulation period, it would be wise to consider the demographics of a plan before choosing one program over another. Turnover should be the biggest consideration, given the issue of lack of portability of nearly any program that involves insurance company guarantees. The total cost of implementing a given strategy should also be a major concern.
The best approach may be to intercept DC investors when they reach retirement and, based on their circumstances, recommend a program that has been customized for their individual situation. This could involve a product solution in the form of an annuity, a process solution in the form a drawdown strategy, or some combination of the two. For instance, one common approach is a drawdown strategy with a qualified longevity annuity contract (QLAC) serving as a backstop against increased longevity.
Most retirees will not be satisfied with the amount they have saved, nor will they be pleased with the potential this amount provides for future income. These investors must choose between either continuing to work or managing their household budgets more aggressively, or some combination of the two.
When investors face the question, “What to do at retirement?”, there are no simple answers. Investors have to look at what they’ve accumulated as well as the likely tradeoffs necessary to support their anticipated retirement lifestyle. Putting sophisticated technology in the hands of capable advisors (in person or from a remote call center) and making this accessible to DC investors at retirement seems like the best answer to the retirement income challenge.