Data and Research August 28, 2015

QLACs Can Reduce Longevity Risk For Some

EBRI found that, even at today’s historically low interest rates, the transfer of longevity risk provides a significant increase in retirement readiness for those who live the longest.
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Longevity reduces retirement readiness for defined contribution plan participants, but purchasing a qualified longevity annuity contract (QLAC) can help, an analysis from the Employee Benefit Research Institute (EBRI) finds.

As part of the assessment of the impact of longevity on retirement income adequacy, EBRI used its Retirement Security Projection Model (RSPM) to establish relative-longevity quartiles based on family status, gender, and age cohort. For the Early Baby Boomers simulated to die in the earliest relative quartile, the Retirement Readiness Rating (RRR) of 75.8% was 19.1 percentage points larger than the overall average for this age cohort. The RRR decreased to 63.1% in the second relative-longevity quartile and 44.9% in the third relative-longevity quartile. For the Early Boomer cohort with the longest relative longevity, the RRR fell all the way to 37.9%.

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Similar patterns were found for the younger age cohorts, but there was a noticeable increase in the RRR range between the earliest and latest longevity quartiles: 37.9 percentage points for Early Boomers, 41.3 percentage points for Late Boomers, and 49.2 percentage points for Gen Xers.

In 2014, the U.S. Treasury Department and the Internal Revenue Service (IRS) issued final rules for creating a QLAC that would be exempt from the required minimum distribution rules that dictate distributions from defined contribution (DC) plans and individual retirement accounts (IRAs) must typically begin by age 70 1/2. EBRI modeled two scenarios under which QLACs are utilized as part of a 401(k) plan, and found that, even at today’s historically low interest rates, the transfer of longevity risk to an insurer under a QLAC provides a significant increase in retirement readiness for the longest-lived quartile, compared with only a small readiness reduction for the general population.

NEXT: What the analysis found

In the first scenario, 15% of the participant’s 401(k) balance would be converted to pay a QLAC premium while simultaneously attempting to partially mitigate the risk of purchasing the product when interest rates are low. The second proposal assumes (some) plan sponsors would be willing to convert the accumulated value of their 401(k) contributions to a QLAC purchase at retirement age on either an opt-in or opt-out basis for the employees.

Results show the percentage change in Retirement Readiness Ratings that result from purchasing a 10-year laddered QLAC of 1.5% of 401(k) account balances from ages 55 to 64 for households in the longest relative-longevity quartile with a QLAC, as well as the impact on all households with a QLAC. In the first scenario, the increase in RRR for Early Boomers in the longest relative-longevity quartile with a QLAC is only 1.9%, but it increases to 2.9% for Late Boomers and 3.5% for Gen Xers. EBRI says the larger percentage increases for the younger cohorts are largely a function of their larger 401(k) balances as a multiple of earnings.

When the premium rates are decreased by 10%, the percent increase in the RRRs (compared to the baseline of no QLACs) vary from 2.5% for Early Boomers to 4.6% for Gen Xers. A 20% decrease in premium rates increases the range of RRR increases to 3.2% for Early Boomers and 5.3% for Gen Xers. A 30% decrease in premium rates increases the range of RRR increases to 4.5% for Early Boomers to 6.7% for Gen Xers.

In the second scenario, the increase in RRR (compared to the baseline of no QLACs) for Early Boomers in the longest relative-longevity quartile with a QLAC is 6.7%, but it increases to 7.3% for Late Boomers and 8.7% for Gen Xers. Similar to results for the first scenario, the RRR increases for each cohort when premium rates are decreased.

A full report of the analysis can be found in the August 2015 EBRI Notes publication on EBRI’s website.

Participants August 28, 2015

401(k) Plan Participants React Visibly to Market Dip

The last full week of August was a test of will for retirement plan participants. Many buckled under the pressure.
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Data from the Aon Hewitt 401(k) Index, which tracks the investment activity of 1.5 million 401(k) investors, shows trading in 401(k) accounts spiked with recent market swings.

On Friday August 21, according to Aon Hewitt, trading activity among retirement plan participants was twice the normal level. Activity on the following Monday was seven times the norm, making for “one of the highest trading days on record,” Aon Hewitt notes.

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Trading volumes returned to more normal levels Tuesday, the index shows, as markets rebounded. It seems pretty clear that a drop in equity asset values spooked a sizable minority of 401(k) investors, Aon Hewitt says. Preceding the market drop on the 21st, there had been no above normal trading in July or August.

It won’t surprise industry practitioners that 401(k) balance movement measured by Aon Hewitt was chiefly out of equities and into fixed income. Put another way, the trades were largely ill-timed and represented participants selling their equity holdings at depressed prices. Fortunately, it was only about 0.17% of net 401(k) plan balances that traded on Monday the 24th, but Rob Austin, director of Retirement Research at Aon Hewitt, says it’s a shame to see even a small group of people reacting poorly to market headlines.

“This summer, we’ve seen significant passivity on the part of 401(k) investors, with extremely low trading volume in the months leading up to Friday’s downturn,” Austin says. “To see investor’s do a complete about-face is concerning.”

It’s all a reflection of advisers’ struggle to instill a long-term mindset in some clients. One message that may help: those who moved money out of equities Friday and Monday and failed to reinvest quickly missed the strong rebound of the following days. Some didn’t even have the option to reinvest in equities as quickly as they would have liked, given that at least one major 401(k) provider was forced to suspend trading due to problems with pricing of mutual fund families.

NEXT: Looking at the impact of market dips on retirement income

As observed by Empower Retirement President Ed Murphy, investors got a fresh taste during the week of the market’s irrepressible capacity to surprise and confuse even the shrewdest stakeholders.

By week’s end, little consensus had emerged in trade media as to whether markets had experienced a flash crash, or if they had betrayed a truer and more sober valuation of global economic growth that we will approach again in coming weeks or months. Murphy suggest “a litany of factors is in play,” including the world oil glut, debt concerns in Chinese and Greek markets, and speculation surrounding Federal Reserve action on interest rates. 

“With each passing tick of the Dow and each frightening headline, the temptation rises for retirement savers to make emotional decisions based on short-term market movements,” Murphy says. “There’s no question that we are living in interesting times.”

There’s more than a small chance that markets could swing wildly again by the time this story is read, but Murphy says that doesn’t matter so much. He echoes the theme of the week for calming concerned retirement investors exposed to vibrating markets: “Nobody can tell you with any degree of certainty what’s going to happen next.”

“Considering all of the factors that influence the global economy, it’s probably easier to predict the weather than the movements in the markets,” Murphy says.

He concludes that presenting the impact of market dips in terms of projected retirement income, rather than as a function of top-line portfolio value, may help investors create and stick to better strategies. The important point is to help participants realize the key role time plays in their portfolio—easing the pain of short-term ups and downs. Online calculators should be helpful in making the case, as a 5% or even 10% market drop today will not cause the projection to fall sharply, if at all.

“The effect of even a large market move on your monthly paycheck in retirement is going to seem insignificant,” Murphy notes. “If one develops that monthly retirement income mentality it’s a great way to diminish any fears and will help prevent making emotional investing decisions.”

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