What’s Your ‘Number?’

Where have years of urging people to save early for retirement and focus on the evolution of investment line-ups and portfolios gotten us? The savings behavior of many Americans has improved greatly, but as participants grow older and realize that the majority of their earnings and savings potential is behind them, they begin to contemplate whether their lifetime of savings can replace their paycheck in retirement.

A recent PLANSPONSOR article, “From Employer to Retirement Paycheck,” emphasized the importance of making retirement readiness understandable to near-retirees and helping to ease their transition from accumulation to distribution. We agree that focusing on lifetime income and translating it into a vocabulary that resonates with participants is crucial.

At age 25, generic tools were sufficient. By retirement age, an individual’s lifetime of decisions—as well as debt load, lifestyle expectations, risk tolerance and savings—have created a unique situation. The logic of investing slowly gives way to the more emotional aspect of wondering what’s next. 

Whether participants dream of an encore career or traveling the globe, they need to know how they will finance their next chapter. Research from the Employee Benefits Research Institute suggests that participants ages 50 to 60 hold nearly 44% of 401(k) assets—a significant portion of defined contribution (DC) plan assets. More than $1.8 trillion will likely transition from accumulation to income generation or cash flow in retirement within the next 15 years. 

Our industry is generally unprepared to satisfy this need. Recent Treasury Department and Department of Labor (DOL) guidance on the use of deferred annuities may influence the development of additional tools for participants who will look to generate retirement income in coming years. However, we know that today, our quantitative vocabulary is not compatible with current needs. We speak of account balances while participants grapple with what their accumulated wealth ultimately means in terms of a sustainable withdrawal rate or a retirement income stream.

Participants need tools and investment products that help them think in income or paycheck replacement terms during the last phases of their savings years. The DOL is making retirement income within plan statements part of its regulatory agenda—more regulatory guidance should be forthcoming. However, as a retirement industry, we should turn our attention to developing straightforward tools to generate retirement income and clearly communicate the available choices to plan participants.

When it comes to helping participants with the distribution phase, many plan sponsors think in black or white terms. On one extreme—the status quo—participants exit the plan upon retirement and take their balances with them. On the other extreme, participants remain in the plan upon retirement and become a long-term irrevocable obligation. We argue that plan sponsors should reject the notion of thinking about retirement income in this binary fashion. In fact, a transition period utilizing a range of tools is not only possible, but we believe is long overdue.

One critical factor to remember when evaluating retirement income solutions is that one size most certainly does not fit all. With respect to future retirement wealth, retirees and near-retirees are notably heterogeneous in contrast to young employees. It is relatively simple and low risk to generalize about young employees—most of their wealth is represented by human capital, which will likely be converted to retirement assets over a working career. The "cost" of errors at this stage is modest and fixable; savings rates can be increased, portfolios can be rebalanced and time horizons are likely lengthy and flexible. Basic design choices—auto-enrollment, escalation, target-date funds as a default investment—are unlikely to be "wrong" for most participants.

Contrast this with a population of 60-year-olds; time horizons to retirement dates are shorter, less flexible, and more variable. Some may intend to retire soon, many years later or not at all. They may have varied expectations about claiming Social Security benefits, their own plans for prolonging household earned income and access to traditional defined benefit plans. Most of their human capital has been converted to financial capital, so portfolio allocation decisions—including annuitizing some or all of the defined contribution portfolio—have more significant consequences, without the benefit of a long time horizon to correct suboptimal choices.

We should still take advantage of existing plans; scale pricing benefits, professional oversight, as well as the fiduciary umbrella provide concrete benefits for most participants. However, overly prescriptive retirement income designs are more likely to be wrong for a significant portion of the population, given the variables noted above. Each participant has different needs and objectives, personal circumstances and time horizons. We can still help participants in the distribution phase, but there is no magic bullet that will work across the board.  

Instead, we should consider a set of solutions that can help serve a wide array of participants within an employer-sponsored plan. This broad toolkit, or "distribution tier," could range from simple in-plan systematic withdrawal programs to annuity marketplaces, where participants can exchange 401(k) balances for an immediate annuity or annuitize a portion of their wealth. More complex, hybrid combinations of investments and annuities of various flavors (fixed, variable, and deferred) are also possible. Customized, but still broadly available solutions (e.g., education regarding spend-down choices) can be structured as opt-in plans, so near-retirees can receive targeted communications (we believe these individuals will be responsive).

As noted earlier, this is not an all-or-nothing proposition. Plan sponsors should help participants understand and select appropriate lifetime income solutions. This can be done in the transition from accumulation to distribution and/or the planning for retirement, without locking plan sponsors and participants in a ‘cradle-to-grave’ relationship.

Finally, we acknowledge that this topic is complex and daunting. The challenge posed by the breadth of needs and solutions can be difficult for sponsors to confront. However, that difficulty should not be an excuse for inaction. As an industry, we can help participants think and plan for more secure retirements. Therefore, we should.

Authors:

Drew Carrington, senior vice president, head of Institutional Defined Contribution in the U.S. for North America Advisory Services for Franklin Templeton Investments   

Yaqub Ahmed, senior vice president and head of Investment-Only Division-U.S. for North America Advisory Services for Franklin Templeton Investments   

Michael Doshier, vice president of Retirement Marketing for Franklin Templeton Investments