Delivering lifetime income: There’s more than 1 approach for 401(k) plan participants

A new research report from AllianceBernstein provides guidance for how defined contribution plan sponsors can evaluate different methods of providing sustainable income for plan participants throughout their retirement.

The report, “Leveling the Retirement Income Playing Field: A Comprehensive Framework for Evaluating Diverse Lifetime Income Solutions,” helps plan sponsors weigh potential outcomes of each approach against its costs and risks. The report notes that despite marked improvements in participation rates, savings rates and asset allocations, many DC plan participants risk outliving their assets in retirement.

“Today, defined contribution plan participants are facing a significant challenge when determining how to spend down their savings in retirement — either overspending and outliving their assets or underspending due to market uncertainties,” said Jennifer DeLong, managing director, head of defined contribution, for AllianceBernstein. “This research seeks to change the current narrative.”

According to AllianceBernstein, DC plans have shifted their focus from growing wealth in the accumulation phase to ensuring income for life in retirement based on the changing preferences of participants. “However, wide-ranging features, such as fee structures, cash flows and investment exposures, make it challenging to assess and compare solutions,” the report said.

AllianceBernstein’s research found that more than one-third of DC plan participants might run out of money in retirement if they do not have explicit lifetime income insurance. The chief reason is that many participants overestimate the withdrawal rates that they can afford. In particular, they risk failure by using “rule of thumb” withdrawal rules, which suggest that withdrawing and spending 4% of total portfolio value each year should be enough to sustain an individual’s lifestyle without running out of money.

However, the report also demonstrated that incorporating insurance into a participant’s asset allocation may improve sustainable withdrawal rates by 70% or more. According to AllianceBernstein, the most effective way to deliver insurance is as part of a qualified default investment alternative.

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The type of income insurance plan that a participant chooses will affect their outcomes, the report noted. In light of that, the report says that lifetime income insurance, such as guaranteed lifetime withdrawal benefits, can generate more total value with less risk for participants. In addition, using certain forms of insurance can result in significant negative side effects for participants, such as growth opportunity cost and mortality risk, and plan sponsors should be aware of those risks and be sure to avoid any unintended consequences.

According to AllianceBernstein, the presence of insurance allows a higher exposure to growth assets within a fund’s asset mix, allowing longevity risks to be significantly reduced without an incremental cost versus a traditional target-date fund.

“Following the passage of the SECURE Act in 2019, the number of retirement income solutions has continued to increase. Plan sponsors need to both understand and evaluate a wide variety of options, including those that utilize insurance,” said Christopher Nikolich, head of glide path strategies for AB and co-author of the report. “By publishing this new research, we strive to create a more level playing field for assessing, quantifying and illustrating the trade-offs for each path to securing income for life.”

AllianceBernstein developed a framework to help plan sponsors compare different methods for supplying sustainable income throughout retirement. The framework emphasizes assessing each individual rather than an average participant and measuring total costs rather than just explicit fees. The framework assesses the combination of income and remaining account balances throughout participants’ lifetimes; quantifies the trade-offs among total cost, value and the risks of lifetime income solutions; and considers a participant’s diverse needs.

“For more than a decade, we’ve been partnering with plan sponsors to help them provide financial security in retirement to their plan participants, and we remain committed to this mission,” said Seth Bernstein, president and CEO of AllianceBernstein. “We are excited to now share this research to better equip plan sponsors to evaluate the various lifetime income options and successfully prepare participants for the future.”