By Bill Mischell and Dave Rosenblum
Challenges for Lifetime Income Solutions in DC Plans: What’s Missing?
Lifetime income products are all the rage. It’s impossible to attend a retirement conference without there being at least one session dedicated to lifetime income in defined contribution (DC) plans. While speakers tout the benefits of lifetime income products in DC plans, and some are even brave enough to acknowledge the shortcomings, the in-plan solutions available in the market aren’t catching on like the industry would have hoped. Based on our discussions with large companies, it’s clear that participants are looking for lifetime income solutions that protect against outliving their retirement savings. Many employers are eager to assist but stop short of offering a solution. Additionally, for those companies that have implemented an in-plan solution, few participants choose annuity distributions. Why haven’t more companies adopted lifetime income solutions and why is utilization so low among those that have?
For companies that either never had a defined benefit pension plan or froze their pension plan years ago, the need for lifetime income among retirees and near-retirees is growing. We agree that pooling longevity risk through annuities is a sensible approach that should be part of most retirees’ financial plans. Many studies show the shortcomings of the current DC landscape in helping individuals make their savings last for their lifetimes without sacrificing their planned standard of living. It doesn’t help when financial advisors use conservative life expectancies that short-change retirees on their monthly income. Also important, especially recently, is the need for inflation protection so the purchasing power of a retiree’s savings doesn’t erode over time.
Given the need and desire from both employers and participants, why have employers been reluctant to adopt in-plan annuity options and why are participants hesitant to elect these options when they are available? The reluctance from both employers and participants stems from a variety of legal, practical, and psychological barriers.
Employer Challenges
Fiduciary Risk
- Selecting and Monitoring Products: Employers face fiduciary risk when selecting and monitoring in-plan solutions. Despite the Safe Harbor provisions for lifetime income solutions, many plan sponsors lack the expertise to evaluate and oversee various insurer products, even with the help of investment advisors. If a plan selects a product as the best fit and later finds it unsuitable, replacing it can be complex, especially if participants’ funds are tied up in the existing product.
Utilization Concerns
- Low Participation Rates: Employers may be hesitant to add complexity to their plans without assurance that participants will value the option. The low utilization rates of in-plan annuities among companies that offer them contribute to this hesitation.
Cost Considerations
- Perceived High Costs: Annuities are often perceived as expensive due to high commissions. Although industry voices argue that fiduciary responsibility is based on the “reasonableness” of fees, concerns about “excessive” costs remain a barrier for many employers.
These concerns about fiduciary responsibilities, low utilization rates, and perceived high costs have led many companies to avoid implementing in-plan solutions.
Participant Challenges
Behavioral Factors
- Inertia: Many retirees manage their investment accounts as they did while employed. Without a deadline to choose an in-plan annuity, they tend to stick with the status quo.
Pricing Issues
- One-Size-Fits-All: In-plan solutions are required to use the same life expectancy assumptions for both genders, leading to inequitable outcomes, particularly for men. (see our article DC Lifetime Income Solutions – Who is Getting Short Changed?)
- Lack of Competition: With generally only one insurance company providing the annuity option, participants may wonder if they are getting the best deal. Additionally, in-plan solutions are often priced individually rather than using group pricing which could offer better rates.
Advisors’ Influence
- Financial Advisors: Retirees often seek advice from financial advisors, who may steer them away from annuity products.
Concerns About Legacy
- Allocation Anxiety: Many retirees worry that by allocating a significant portion of their savings to an annuity, they might forgo leaving money to their heirs if they die prematurely.
Addressing These Concerns
The concerns expressed by participants and employers are valid. The limitations of in-plan solutions may be too significant to overcome, and consequently in-plan annuity options may never fully meet the needs of participants and employers. However, as the industry continues to evolve, providers must address these limitations to improve adoption and utilization.
One potential solution is to use out-of-plan annuities alongside a DC plan. This approach could address many of the challenges associated with in-plan options.
- Greater Flexibility and Customization: Participants could select from a broader range of products tailored to their specific needs, including inflation protection and return-of-premium options.
- Reduced Fiduciary Risk and Administrative Burden: Employers could offer valuable retirement income solutions without the complexities and risks of in-plan annuities.
- Enhanced Participant Choice: Allowing participants to explore annuity options outside the plan empowers them to make informed decisions.
- Gender-Specific Mortality: Out-of-plan solutions can use realistic mortality assumptions, ensuring fairer outcomes for everyone.
- Group Pricing and Competitive Bids: Insurers can compete for business, offering better prices through group pricing.
By embracing out-of-plan annuities, employers can provide a robust retirement solution that meets the diverse needs of their workforce, ultimately enhancing the financial security and satisfaction of their participants.
