Tipping point: Automatic defaults for retirement income
These trending features could be incorporated into the majority of employer-sponsored plans within the next five years.
The concept of adding automatic features to defined contribution plans has proven to be successful at improving retirement savings among participants in employer-sponsored plans. Now, experts suggest automatic plan defaults could be implemented in DC plans to provide retirement income in addition to building savings.
The Institutional Retirement Income Council (IRIC) said it anticipates a tipping point in the next five years where income solutions will be added to a majority of plans. The prediction is part of IRIC’s recent white paper “From Auto-Enrollment to Auto-Escalation to Auto-Income: How DC Plans Can Evolve to Improve American Retirement Security.”
The change in employer-based retirement plans from defined benefit plans that provided lifetime income to defined contribution plans that focus primarily on building savings has shifted risk and responsibility to individuals for managing their finances in retirement. The paper cited statistics that found less than 5 percent of employees today participate in an employer-based DB plan, compared with nearly 40 percent in 1979. Meanwhile, DC plans were meant to provide supplemental savings but have now evolved into the primary accumulation vehicle for many Americans.
In 2006, the Pension Protection Act removed barriers to automatic enrollment features in DC plans by removing legal liabilities regarding state garnishment laws and providing relief for fiduciaries who select default investments. Since then, employees have generally demonstrated trust in their employers, which has translated into an acceptance of many automated plan features. Citing research by Principal Financial Group, the paper noted 90 percent of participants stay in plans once they are automatically enrolled and 83 percent of employees are fine with an automatic enrollment at a 6 percent deferral.
That acceptance of automatic features could prove crucial in helping build additional retirement security through lifetime income options in DC plans, the paper said. In fact, legislators have even considered requiring a portion of 401(k) and 403(b) plans to be available for distribution in a form that provides guaranteed lifetime income.
“Given the current lopsidedness of the historical three-legged stool of American retirement, auto-income — the practice of defaulting a portion of DC account balances into investment vehicles that make protected lifetime income a default from which participants could opt out — could well prove to be an appreciated plan benefit,” the paper said.
To help rebalance retirement security, regulators and lawmakers have sought to promote the goal of retirement security through protection from liability for plan sponsors. Target-date funds have emerged as the primary qualified default investment alternative (QDIA) used in DC plans, with 93 percent of all plans now offering them.
In 2014, new guidance and regulations authorized the use of guaranteed income in the form of deferred fixed annuities as part of a plan’s QDIA, said the paper. In 2016, the Department of Labor clarified that a reasonable plan fiduciary could prudently select as a default fund an investment with guaranteed lifetime income elements, and the SECURE Act of 2019 provided an annuity safe harbor which limits a plan fiduciary’s liability.
“Integrating income solutions into a plan’s QDIA will significantly increase America’s retirement security by defaulting participants into an institutional solution selected by a fiduciary that can utilize the bargaining power of the plan’s assets, thereby delivering additional income to plan participants,” said the paper.
“As such, we believe that there is at least one more chapter to be written in the history of QDIAs, and it is starting to be written by innovative companies and their service providers determined to bring forth the next generation of QDIAs that deliver not only professional money management during the accumulation phase of a worker’s life but also retirement assurances during the decumulation phase via the integration of guaranteed income into plans’ QDIAs.”
Offering such options is beneficial to employers by aligning with the retirement goals of employees while avoiding some of the drawbacks that pension plans previously presented, such as rising costs, financial statement volatility and a societal trend toward job mobility, the report said.
Employees who delay retirement can be costly to employers through higher health care premium costs, lower productivity and higher incidence of disability. That’s why plan sponsors might seek to adopt retirement programs that help employees retire on time. Automating retirement income can also help with recruitment and retention and narrow gaps in retirement savings among diverse groups.
For employees, establishing secure retirement income streams through a trusted employer can protect their financial wellbeing as they age and cognitive declines and impaired financial decision-making increase. Annuities also can help retirees weather market volatility in other areas of their retirement savings.
Many of the traditional objections to in-plan annuities have been mitigated by legislation, including concerns that plan fiduciaries could be held responsible for an insurer’s inability to meet its financial obligations in an annuity.
In addition, sponsors are no longer entangled with recordkeepers and insurers if they opt to discontinue annuity options because participants are able to receive a rollover as part of a distributable event in those cases, said the paper.
Kristen Beckman is a freelance writer based in Colorado. She previously was a writer and editor for ALM’s Retirement Advisor magazine and LifeHealthPro online channel. She also was a reporter for Business Insurance magazine covering workers compensation topics. Kristen graduated from the University of Missouri with a degree in journalism.
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