Participants in defined contribution retirement plans – along with almost everyone else – need to think about how they will pay their bills in retirement. Unfortunately, many fail to realize the importance of having a secure source of lifetime retirement income. It is unlikely we will see a return to the defined benefit pension plans that may have helped pay for their grandparents’ retirement. It is also uncertain how much of a safety net Social Security will provide. And the risks that participants will face can erode the retirement savings they spend a lifetime building. Plan sponsors can help address many of the risks by offering an in-plan lifetime retirement income solution. The plan sponsor’s task in selecting the product is no greater than any other fiduciary decision, and it can provide a significant benefit to the employees. One solution that may provide the greatest overall benefit is “guaranteed income,” in the form of an in-plan deferred income annuity (DIA).
There are more than half a dozen issues that can adversely impact retirees:
- Investment risks
- Interest rate risk
- Withdrawal rate risk
- Cognitive impairment
- Rising healthcare costs
- Public policy changes.
The overarching consequence of these risks is that retirees may not have enough money to live comfortably in retirement. These risks and how a deferred income annuity helps to address them are reflected in the chart in the next section.
The financial services community offers a number of solutions designed to address at least some of these risks. They include professionally managed accounts, payout mutual funds, guaranteed minimum withdrawal benefit (GMWB) accounts, immediate annuities purchased at retirement, “longevity insurance” (that is, a type of deferred annuity paid for at retirement under which payments do not begin until the retiree reaches age 80 or 85) and in-plan deferred income annuities. None of these solutions addresses the last two risks — rising health care costs and public policy changes — and only the in-plan DIA addresses all of the others. Participants who purchase an in-plan DIA can benefit from institutional pricing compared to the retail pricing of an outside-the-plan annuity. Further, under an in-plan DIA, each pay period, a participant can buy guaranteed lifetime income payable at retirement; the participant pays the current annuity purchase rate at the time of purchase. As annuity purchase rates fluctuate, these per-pay-period purchases provide a benefit similar to that of “dollar cost averaging.” That is, by purchasing in multiple rate environments, the risk of purchasing in an unfavorable environment is reduced. Essentially, this can help “average out” rate environments over time. A participant who consistently invests in the DIA will have a more secure source of retirement income when he or she leaves employment (what we refer to as “guaranteed income”). Participants who are unable to take advantage of “risk environment averaging” — which might happen, for example, when a DIA was not previously available in the plan — can still benefit from an in-plan DIA. This is because they have the flexibility to make a lump sum purchase at a time of their choosing, vs. having to do so at retirement when they are forced to accept whatever the rate is at the time.
The following table shows the retirement risks and the way in which an in-plan DIA can help with most of these risks, assuming it is prudently selected:
1 See, “How can I make my retirement savings last?”, Fidelity Viewpoints, 08/27/2018 https://www.fidelity.com/viewpoints/retirement/how-long-will-savings-last; see also, “Rethinking the 4% withdrawal rule,”CNBC.com October 28, 2013, https://www.cnbc.com/2013/10/28/rethinking-the-4-withdrawal-rule.html.
2 See, Updegrave, Walter, “Some People Have a Crazy Idea of What They Can afford in Retirement,” Money March 6, 2017, http://money.com/money/4689984/safe-withdrawal-rate-retirement/.
Plan sponsor considerations
Offering an in-plan solution requires that the plan sponsor, as fiduciary, act prudently in selecting the product and provider. Plan sponsors must follow the same process whether they are selecting a managed account solution, a specialized payout mutual fund, a GMWB product or some form of income annuity:
- Assemble relevant data about the investment.
- Assess the data.
Make an informed and reasoned decision.
- Document the decision and revisit it periodically.
If necessary, the sponsor can employ a financial professional or other consultant to assist in the data gathering and assessment. Selecting an in-plan DIA is no different, though the data to be assembled varies somewhat. The main factor a sponsor needs to assess, in addition to the terms, cost and features of the product, is whether the insurance company will be able to fulfill its financial obligation to pay lifetime income in retirement. This does not mean a plan sponsor needs a crystal ball to see into the future…only that the sponsor assess data available today that indicates whether the carrier is likely to meet its promises in the future. One DIA that offers features of the type described earlier and at prices that compare favorably to other DIAs currently available in the marketplace is Principal Pension BuilderSM, offered by Principal Life Insurance Company, a member of the Principal Financial Group®. This product enables a plan sponsor to offer the DIA within its defined contribution plan investment lineup. Participants can then purchase guaranteed income by making a partial lump sum transfer of their account balance, or by directing future contributions into the DIA. In return, they will receive monthly income payments for life when they retire.
Most retirees today lack the safety net of an employer-provided pension plan. The current defined contribution plan environment places responsibility on employees. They must make most of their own decisions about their post-employment financial well-being. And at retirement, they face risks for which they may be unprepared. The financial services industry recognizes the post-retirement dilemma and offers solutions that can help solve most of the problems. But plan sponsors need to be made aware that the risks exist and that solutions are available, solutions that can provide a significant benefit to their employees. They also need to understand that their task in selecting a retirement income product is no greater than any other fiduciary decision they make about their plan’s investment alternatives. One alternative that may provide the greatest overall benefit is “guaranteed income,” in the form of an in-plan deferred income annuity.
To access the full white paper go to https://secure02.principal.com/publicvsupply/GetFile?fm=HZ2364&ty=VOP&EXT=.VOP.
The ability of Principal Life Insurance Company to pay the guarantee is based on the claims-paying ability of the general account and is subject to the terms of the contract.
Principal Pension BuilderSM is a deferred income annuity rider available through certain group annuity contracts with Principal Life Insurance Company, a member of the Principal Financial Group®, Des Moines, Iowa, 50392. Principal Pension Builder is not available to plan sponsor located in New York.
Principal Pension Builder provides for the purchase of deferred income annuities that provide guaranteed income in retirement. Contributions and transfers used to purchase guaranteed income through Principal Pension Builder will no longer be subject to market gains or losses. In exchange, the participant is purchasing a guaranteed future income stream. In no instance shall the Income Start Date be earlier than your Normal Retirement Date unless you separate from service prior to the plan’s Normal Retirement Date.
Dollar Cost Averaging involves continuous investing. Investors need to consider their ability and willingness to continue investing through periods of low-price levels. This does not assure a profit nor protect against loss in declining markets.
The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment advice or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.
Insurance products and plan administrative services provided through Principal Life Insurance Co., a member of the Principal Financial Group®, Des Moines, IA 50392.
© 2019 Principal Financial Services, Inc.