Pension plans are providing an ever-decreasing portion of retirement wealth as wave after wave of Baby Boomers reach retirement. In and of itself, this is neither surprising nor remarkable. What is remarkable, though, are two typical characteristics of what we are being left with regarding retirement wealth.
First, the jettison of pension plans means relying on defined contribution plans as the provider of principal retirement wealth. This is suboptimal inasmuch as these plans are typically 401(k) savings plans, originally introduced as a sideline fringe benefit scaled for purposes less than what they’re now required to deliver on. This is mostly a benefit-level issue of which we have seen recent hints of amelioration—namely, the industry recognizing that in an all-account-based retirement world, saving 16% of annual pay is in the ballpark, not the historical mode of 6% employee deferral (plus maybe 6% employer match totaling 12%). This relates to the second endangered characteristic, which needs to be brought into brighter focus: an in-plan solution for generating guaranteed retirement income.
Pension plans are wonderful for participants in that everyone is automatically a participant, automatically earning benefits on a meaningful trajectory, and automatically having the ultimate retirement wealth delivered on a lifetime guaranteed basis. Yes, 401(k) plans are trending this way on the first two, and the third is quickly emerging as another area where we need more pension-like alternatives.
One may generalize by saying that retirees take their 401(k) balances and roll them over when they retire. An economic conundrum baffling academics is that none or very few of these folks take advantage of insured annuities even in the midst of robust studies identifying them as an optimal solution for retirement income in face of investment uncertainty and longevity risks. This raises two subtle yet important points.
First, the all-or-nothing decision causes the tilt of decision makers to move toward this circumstance. This is observable in the handling of pension assets at the point of a participant’s retirement. Many pension plans offer the choice between a lump-sum payout (into a rollover, for example) or an annuity. When presented with all or nothing, most retirees select lump sums, when in many—if not most—situations, allowing a mix or partial annuitization and partial lump sum would be better for the participants and welcomed by them.
Second, participants have it sweet when their monies are in their sponsor plans. They get all of the substantial benefits of institutional (or wholesale if you will) pricing. When their money exits the plan, as a rollover for example, they face retail pricing, which is significant. The move to a lump sum/rollover paradigm has transferred not only the varied risks to participants, but also the ongoing and significant administrative and management costs as well.
The typical outcome is using a financial planner (for a fee) to advise how your (expensive) IRA funds ought to be invested (at retail costs) and whether to take out 4% of your account as retirement income each year or 3.5% or 4.5%. Note that, in a pension plan, the associated payout rate hovers around 8% annually. The latter is guaranteed for life while the former is not.
The solution is to have 401(k) plans with a set of alternative retirement income generators in a manner parallel to having a set of alternative investment vehicles that the participant may choose between. Additionally, this set-up, again paralleling other valuable 401(k) features, should include a default option, the Qualified Default Retirement Income Option (QDRIO), which might include allocating a portion of an account’s assets to an insured product such as a Guaranteed Lifetime Withdrawal Benefit (GLWB) to maximize payout levels. A necessary step in this direction is regulatory support from the U.S. Department of Labor and the Internal Revenue Service (IRS)—again, in just the same mode as is already provided for auto-enrollment, auto-escalation, and 404(c) liability protection, as with investments offered and the Qualified Default Investment Alternative.
Enhancing the financial security of our retirees is a central tenet of our business. Providing straightforward options and education with common sense attention can help achieve this. Combining in-plan, out-of-plan, near-retirement, and at-retirement options further provides significant protections, which recently reissued fiduciary rules are attempting to provide to new retirees who are left holding the $16 trillion bag. There’s approximately that much money in account-based retirement plans such as 401(k)s and IRAs, and right now, there are many viable retirement income alternatives for the retiree going out the door.