Lifetime retirement income: Don't let 'perfect' be the enemy of 'very good' in helping participants

Offering retirement plan participants retirement income solutions is not only very doable these days but there are many reasons why plan sponsors might want to make it a priority.

That’s according to retirement researcher and author Steve Vernon, who has published a series of essays outlining how DC plan sponsors can help older workers use their retirement savings to generate reliable, lifetime retirement income.

The essay series draws from Vernon’s work conducted while a research scholar at the Stanford Center on Longevity, in collaboration with the Society of Actuaries, and on his latest book, “Don’t Go Broke in Retirement: A Simple Plan to Build Lifetime Retirement Income.”

In the following Q&A, Vernon brings much-needed clarity to the subject of lifetime retirement income solutions: discussing misconceptions, why plan sponsors should offer such solutions, what decisions participants need to make, and more.

BenefitsPRO: Do plan sponsors understand what you’re talking about when you talk about lifetime retirement income? Are there any misconceptions that need to be cleared up?

Steve Vernon: Some plan sponsors understand, and some don’t. And some plan sponsors understand the issues with lifetime retirement income solutions, but their plates are already full with other issues. Or they are worried about fiduciary issues, as I’ll discuss later.

Hopefully plan sponsors will make offering retirement income solutions to their plan participants a priority of their time. Implementing viable retirement income solutions is an inexpensive plan improvement — in today’s economic environment, plan improvements can be rare!

Here’s one thing for plan sponsors to think about: If plan participants are unsure if they have saved sufficient assets to retire, then their default assumption is to continue working.

The retirement industry is well aware of the power of defaults in decision-making, so there could be many older workers who continue to work as long as they can.  Eventually this will be counter-productive for both the participants and their employers.

So if plan sponsors want to encourage their older workers to retire, one of the best ways is to help participants assess if they have enough financial resources to retire, and help them implement reasonable retirement income strategies.

Here are a few misconceptions that need to be cleared up with plan sponsors:

Some plan sponsors automatically assume that to implement retirement income solutions, it must mean implementing an annuity option. While that is one option for a plan sponsor to consider, there are other possibilities as well.

For example, a plan sponsor could implement a Social Security bridge payment option, which would enable a participant to maximize their expected lifetime Social Security income by delaying the start of those benefits.

A Social Security bridge payment would use a portion of retirement savings to pay monthly installment payments for a fixed period of time, approximately equal to the Social Security benefit the participant would be delaying.

Our research shows that’s one of the best possible uses of retirement savings that would generate risk-protected retirement income.

Another possibility is to pay installment payments from invested assets where the monthly payment is determined in a way that will most likely last for life, but with no guarantee.

Another misconception is that retirement income solutions haven’t been fully developed.  In fact, there exists substantial research on robust retirement income options that could practically be implemented today.

I’ve developed a substantial body of research over the last 7 years on this topic at the Stanford Center on Longevity, in collaboration with the Society of Actuaries — five very detailed reports, a handful of shorter papers, and a consumer-facing book. Other researchers have also produced analyses of viable retirement income strategies that could be implemented in a DC plan.

The fact is, there are no “perfect” solutions, they all have their pros and cons. It is futile to wait for the “perfect” solution. But there are many “very good” retirement income solutions that could be implemented today. We shouldn’t let “perfect” be the enemy of “very good.”

Another misconception is that all the plan sponsor needs to do is offer one retirement income solution. In fact, they could offer multiple solutions through a retirement income menu, that complements the familiar investment menu.

Such a menu would offer options to allow a retiree to build a retirement income portfolio that meets their goals and circumstances.

DC plans don’t offer just one investment fund; that couldn’t possibly meet the goals and circumstances of all their participants. Similarly, they should offer more than one retirement income option. As a minimum, a retirement income menu could include three distinct options:

• a Social Security bridge payment
• an installment payment using invested assets, and
• some type of annuity (either in-plan or rollover to an annuity bidding platform).

The second essay that I recently published with the Society of Actuaries provides details on the retirement income menu.

What potential regulatory challenges do sponsors/advisors/providers face?

There is nothing from a regulatory perspective that would prevent a plan sponsor from implementing a retirement income menu, as described above. They would need to comply with the usual fiduciary responsibilities.

It would help greatly if plan sponsors had safe harbor protection for a retirement income menu with at least three options, as I described earlier. This is similar to the regulatory protection offered for the investment menu through ERISA Section 404c, which provides a safe harbor for an investment menu if the plan sponsor offers at least three distinct investment options.

Why is it important for plan sponsors to help and how can they do so?

Developing viable retirement income solutions is beyond the skills and experience of most pre-retirees.  And surveys show that most pre-retirees do not work with financial advisors. Plan sponsors could help tremendously by offering “check the box” solutions that are viable and reasonable, accompanied by robust education material.

Plan participants generally trust their employer, whereas many participants might be uneasy devising retirement income solutions on their own or shopping for financial advisors or financial institutions for help with generating retirement income.

Also, if retirees keep their money in the DC plan, they enjoy the fiduciary protection that such plans offer. When they roll their money out of the DC plan and over to a financial institution or financial advisor, there is no requirement that they act in the best interest of the retiree.

Does this involve any fiduciary risk above and beyond what risks other funds/investments etc. offer?

I believe that under the current environment, a 401k plan committee could rely on the so-called “prudent person” rule. A committee could conduct a search of viable retirement income solutions and make an informed choice as to the options to offer their plan participants. There are ERISA attorneys who support this perspective, and many retirement consultants who could assist a 401k plan committee.  Please keep in mind that I’m an actuary, not an ERISA attorney.

There have been DC plan sponsors who have offered retirement income solutions and have not been challenged successfully by a lawsuit (United Technologies, for example).

Also, the safe harbor for a retirement income menu, described above, could significantly help ease the minds of DC plan committees to design and implement a retirement income menu.

How can sponsors best communicate information about lifetime retirement income to plan participants?

With most 401k plans, there is little or no mention of retirement income options in their communications materials. Instead, plan sponsors could provide the same type of robust communications that they currently offer to communicate investment options.

They would describe each retirement income option, its pros and cons, goals, and risks. They could use hypothetical participants to show stories of how people made their decisions. They could provide online modeling tools and retirement income statements to show how much retirement income could be generated by various retirement income solutions, and at various retirement ages.

They could use the same media as the communications for investment options — online print, video, tutorials, modeling tools, account statements that are enhanced to include estimates of retirement income.

The fourth essay that I recently published with the Society of Actuaries discusses the last point — retirement income statements. If not designed appropriately, retirement income statements have the potential to dangerously mislead pre-retirees. If prepared appropriately, they present an important “teaching moment” for pre-retirees and retirees.

The basic idea is to put as much effort into communicating retirement income solutions as they do communicating investment solutions.

What decisions do participants need to make?

The first essay that I recently published with the Society of Actuaries discusses the top five retirement income decisions, in order of priority:

1. When and how to retire (by how to retire, I mean do you work part time for awhile, or retire completely and earn no money from working)
2. When to start Social Security
3. Build out your retirement income portfolio using invested assets, pensions, and annuities
4. Decide which living expenses to reduce (because research shows that the majority of older workers have not accumulated enough savings to retire full time at age 65 under their current amount of spendable income)
5. Whether to deploy home equity, to supplement retirement income from Social Security, DC plans, and IRAs. This could be accomplished from downsizing and realizing a capital gain that could be reinvested to generate retirement income, or through a reverse mortgage.

The fourth point is particularly important. People need to understand how much retirement income they might receive from all their sources of income – Social Security, pensions, invested assets, annuities. Then they will know how much money they can afford to spend, and they have a target for reducing their spending.

Or they might decide they should work longer, to let their Social Security and savings grow. Or they might decide they need to deploy their home equity.  Hopefully this assessment will lead to realistic decisions that will increase their financial security over a potentially long retirement.

Do you see advisor interest in lifetime retirement income?

The simple answer is yes, there is significant interest from financial advisors with generating retirement income. I’ve been speaking recently at several advisor conferences on this topic.

What else is necessary to get across to those in the employer-sponsored retirement industry?

Many professionals are interested in a default retirement income option, pointing to the success of default investments and automatic enrollment. I have mixed feelings about a default retirement income option.

The success of default investments and automatic enrollment has been to engage participants to start saving, with the hope that they will become more engaged over time and make elections that are better for them. We are seeing the best saving results with engaged participants.

When it comes to retirement income, the decisions are more complex, with higher stakes, than the saving and investing decisions made throughout the working years. It’s much better to have an engaged pre-retiree and retiree, to make informed decisions that meet their goals and circumstances.

As a result, I’m advocating a default decision process, whereby the participant is defaulted into a guided decision process.

Hopefully the outcome is elections that personalize their elections to address their unique goals and circumstances. The participant could always opt out of the guided decision process.

Then, the default retirement income option could be designed in a way to incentivize them to use the default decision process.

Currently, the only retirement income option with regulatory support is the IRS required minimum distribution, coupled with the default qualified default investment option (QDIA) for retirees.

Our research demonstrates that this is actually a viable retirement income strategy for middle-income retirees, when coupled with optimizing Social Security. The advantage of such a default is that it should engage participants to make a positive election, since the RMD now starts at age 72. Most retirees may need to access their savings sooner than age 72.

The third essay that I recently published with the Society of Actuaries goes into detail on these ideas regarding a default decision process and the default retirement income option.

Also, we need several prominent plan sponsors to implement and communicate retirement income solutions, to demonstrate that it can be done. United Technologies has been the poster child for such an example, and it would help if other prominent plan sponsors joined them.