Defined contribution retirement plans are commonly criticized for their lack of a guaranteed lifetime income, but with the availability of annuity options for retirees, this concern is largely unfounded. Any retiree with a lump sum of money saved has access to a variety of annuities, even if having these products available internally in one’s employer-provided retirement plan may be preferable. Despite the value of in-plan guaranteed income solutions, signs point to a marked lack of these options in existing defined contribution (DC) plans.
A 2021 Black Rock survey indicates that 96 percent of 225 large 401(k) and 403(b) plan sponsors feel responsible for helping participants generate and/or manage their income in retirement, and 82 percent of plan sponsors that do not currently offer a product that provides lifetime income such as an annuity are likely to add one in the next 12 months.
A 2020 Retirement Income Institute research paper found that 81 percent of defined contribution plan participants indicate that they are somewhat or highly likely to prefer a retirement plan that substitutes guaranteed income for bond investments. Despite these and similar survey trends showing a growing interest in guaranteed income solutions in defined contribution plans, a Profit Sharing Council of America (PSCA) report in 2020 shows that only 16.3 percent of defined contribution plans surveyed actually offer a retirement income solution for participants.
While there is some evidence that public sector DC plans may have better numbers, the reality is that retirement income solutions continue to be an afterthought in the design of defined contribution plans. The reasons stated in the PSCA report for the disparity in DC plan sponsor intent and actual adoption of retirement income solutions include lack of demand from participants, product and administrative complexities, high perceived costs, lack of portability, and perceived fiduciary risks. Another reason is that only 19.9 percent of plan consultants and advisors recommended retirement income solutions for their clients’ plans. Why the reluctance to recommend retirement income solutions to their plan sponsor clients? If the need for guaranteed retirement income in retirement is recognized and plan sponsors agree that providing retirement income solutions is a high priority, then the slow adoption rate needs closer examination.
The array of available retirement income solutions for DC plans can be daunting to those only familiar with the standard array of mutual fund-driven investment menus. Finding the right fit includes the need to understand how each product type works and how to mesh it into a coherent plan design that does not overwhelm participants. Plan sponsors and their advisors need to come to grips with a variety of products including immediate and variable annuities, deferred annuities (including qualified lifetime annuities), and guaranteed minimum withdrawal benefit solutions, all in addition to the usual do-it-yourself and managed payout options typically offered.
Interestingly, the hesitation to add income options may have more to do with a failure by plan sponsors and their consultants to make retirement income the explicit and primary purpose of the plan. Making this simple change of perspective (i.e., retirement income first and wealth accumulation second) as recommended by Reason Foundation’s best practices for defined contribution plan design would by necessity lead to increased use of the available retirement income solutions. This has been the case for higher education DC plans for decades.
Policymakers should also know that reluctance borne from concerns of complex and hard-to-implement administration is misplaced. The ability of third-party recordkeepers to include retirement income solutions into both their plan and participant services while providing a customized set of retirement income planning services currently exists. These services should mitigate plan sponsor and advisor concerns about administrative complexity.
Some of the fiduciary risk concerns have been addressed with the passage of the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act), which provided greater safe harbor protections for limiting the plan sponsor’s liability if the annuity provider is not able to fulfill the annuity contract. While this safe harbor does not technically apply to public sector plans, the fiduciary prudence practices provided should be useful nonetheless.
The concerns regarding fiduciary risk due to the use of lifetime income solutions are also questionable given the fact that private-sector defined benefit plan sponsors have been using group annuity purchases as a de-risking tool with a record sales volume of over $38 billion in 2021. This level of annuity purchase activity in the private sector provides some valuable assurance that the level of risk involved in using retirement income solutions for providers of DC plans can be successfully managed.
Moving the needle toward an expansion of retirement income products in defined contribution plans would be a meaningful step in better addressing retirement financial security. The benefits to the retirement security of DC plan participants are well worth the effort.
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