Benefits August 1, 2024

How Sponsors Should Consider Different Lifetime Income Options

Sponsors have both legal and practical ramifications to weigh.

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Art by Antonio Uve

For sponsors and participants considering retirement income options, such as systematic withdrawals and annuities, there many evaluations to make. These include the fiduciary duties of plan sponsors under the Employee Retirement Income Security Act and which options best suit the needs and preferences of participants.

ERISA and Fiduciary Duties

Despite all the new products available to plans, “underneath it all, the same standards apply: prudence and loyalty,” says David Levine, a partner in the Groom Law Group, referencing the core fiduciary obligations under ERISA.

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The retirement world is constantly evolving, and “there are always new solutions as people try to address what people perceive as room for enhancement,” Levine says. Sponsors should evaluate the direct and indirect costs, the outcomes and the recordkeeping requirements of any option they are considering.

When it comes to fees associated with lifetime income options and products, sponsors should ask themselves, “in light of these fees, are the benefits to the plan and participant worth it?” There is no right or wrong answer, necessarily; a fiduciary just needs a prudent process for deciding and a “basis and rationale” for the final choice.

Levine adds that sponsors are not required to offer features such as managed accounts or annuities, so there is no need to feel overwhelmed by the large volume of options. Sponsors should consult with their adviser or vendor about which options might be best for their participants, and fiduciaries should be sure they understand any option before selecting it and should be ready to commit to continuously monitoring the prudence of the product, since fiduciary duties are ongoing.

Guaranteed and Nonguaranteed Options

Laurie Lombardo, a vice president at Voya Financial, says “there is a lot out there for participants to choose from,” but retirement income products broadly fall into guaranteed and nonguaranteed options. According to Voya customer surveys, most participants are interested in both categories.

Guaranteed lifetime income options will essentially always be some kind of annuity or other insurance product, Lombardo explains: “An insurance company will be on the hook for making the payments to the participant.”

A guaranteed option can involve directly investing into an insurance product or later transferring plan funds into an annuity that provides a stream of income to last for the rest of the participant’s life.

Some guaranteed lifetime income options are found embedded into target-date funds, such as BlackRock’s LifePath Paycheck TDF, which moves assets over to lifetime income as the participant ages past 55 years old.

A nonguaranteed option typically involves structuring withdrawals from a participant’s plan balance such that the participant continues to get a regular income, though it only lasts as long as the funds do. In the absence of a systematic withdrawal feature, a participant is left to withdraw funds manually and irregularly, which can make budgeting more difficult.

Lombardo says that according to Voya’s data, only 42% of plan sponsors offer systematic withdrawals. Given the feature’s relative simplicity, it is “probably one of the first things a plan sponsor can do toward meeting the retirement income needs of their participants.”

Between these two categories, there is not much of a gap in popularity, Lombardo says, but “there is a gap in utilization,” because “participants are not aware of all the options.” She says sponsors should also invest in educational tools to help participants decide which options are best for them. “Participants won’t go out and buy them; they need to understand them,” she says, and working with financial professionals can make a big difference.

Benefits August 1, 2024

Managed Accounts Provide Opportunity, Challenges as a Retirement Income Solution

With their ability to provide personalized advice, managed accounts have become a more attractive retirement income solution, but the high fees attached to them continue to be a major criticism.

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Art by Antonio Uve

Managed accounts have been around for more than 20 years as a defined contribution plan option, but the tailored investment vehicles have evolved considerably over the years, allowing plan sponsors to consider them as a tool to offer a retirement income solution to their participants.

With more information coming from recordkeepers and more engagement from participants, managed accounts have become much more than “glorified target-date funds,” according to Julie Varga, senior vice president and investment and product specialist at Morningstar Investment Management—a provider of managed accounts.

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The Pension Protection Act of 2006 allowed managed accounts to serve as defined contribution plans’ qualified default investment alternatives, leading to greater availability of managed accounts in plans. For example, Vanguard’s “How America Saves 2024” report revealed that 77% of participants were offered access to managed account advice in 2023, compared to 60% in 2019.

Critiques of Managed Accounts

Despite increasing availability of managed accounts, growth has been relatively stagnant in the last few years, as 77% of participants were also offered managed accounts in 2022, and only 7% of participants are actually using a managed account program, Vanguard’s data shows.

Some firms have been more critical of managed accounts, largely because of the fees that are often attached to the personalized service. For example, NEPC argued in a report published in June that after including the fee charged by the managed account provider, savings advice has a “negative return on investment after the first year.”

NEPC argued that this is mainly because managed account fees are charged based on participants’ total assets rather than on changes to their annual savings.

“We believe savings advice should be a one-time charge commensurate with the incremental change in participant’s savings rate, rather than a recurring expense,” NEPC stated in its report.

Benefits of Managed Accounts

Meanwhile, Varga says despite the fees, participants are getting a “much more personalized and holistic set of recommendations” that they likely were not receiving in the past with TDFs.

“[A] managed account is really more akin to sitting down with a financial adviser, and not everybody can obviously do that,” Varga says. “[Some participants] may not necessarily have the means or a large enough balance to [access a financial adviser] , but the fact is, managed accounts provide more than just an investment solution.”

Varga explains that managed account offerings also include recommendations, indicating when an individual should retire or how they should optimize their plans for claiming Social Security. The high level of personalization and advice, Varga argues, is a justification for the fees.

According to Morningstar, the asset-weighted average on fees for U.S. target-date funds as of June 2024 is 0.18%. When asked to provide average managed account fee data in DC plans, a spokesperson at Morningstar said the firm does not track this data.

However, Morningstar pointed to a report from Cerulli Associates published in 2021, which stated that fee structures may differ from one provider to the next. It also stated that providers may offer lower fees to plan sponsors that use the managed account as the plan’s QDIA, as opposed to an “opt-in” solution. She adds that managed accounts are also “an ideal vehicle” for including retirement income. If an individual is considering purchasing some sort of guaranteed income product, like an annuity, Varga explains that a managed account can help a participant better understand whether or not they truly need it, as the managed account provider is able to consider all of the participant’s assets and income they will receive in retirement.

Varga says a managed account tool can also help a participant figure out how much of an annuity they should consider purchasing and what percentage of their current account balance they could comfortably allocate to the purchase.

Even if a plan does not offer an in-plan annuity, Varga says a managed account service can recommend where a participant can go outside the plan to purchase an annuity.

George Sepsakos, principal at Groom Law Group, says the main benefit of managed accounts is the ability for the individual to receive a more “bespoke solution.”

“I think [these] solutions offer some kind of additional financial education services and assistance to participants that they might not otherwise have the ability to receive,” Sepsakos says.

Paycheck Feature

When thinking about the types of managed account products available in the marketplace, Kevin Crain, executive director of the Institutional Retirement Income Council, believes hybrid managed accounts are a promising in-plan retirement income solution.

He says managed accounts can be hybrid in two ways. First, it could be a managed account with an embedded annuity structure, or second, it could be a managed account with a retirement paycheck feature. In the latter structure, instead of an annuity funding the retirement income, the investments in the managed account would be providing some sort of paycheck in retirement.

Crain says a managed account with a paycheck feature is likely a simpler solution to implement in-plan, as opposed to an annuity. Essentially, the managed account provider would collect data on the participant’s demographics and information and include a drawdown feature. The participant would elect how long they want to receive payments, but the professional manager of the account would decide all the asset allocations, such as investing some assets more conservatively in order to fund the payments.

“That has a lot of legs because plan sponsors understand managed accounts, [and] they’re already professionally managed,” Crain says. “The retirement paycheck feature is just orderly taking assets out and direct depositing them into a bank account. There are no surrender charges or any of that stuff.”

In addition, Crain says in recent years, more participants are engaging with managed account providers and providing their information, which helps them to provide more accurate advice.

Framework for Selecting a Managed Account

Sepsakos says while there is no “one-size-fits-all” solution for selecting any investment or managed account provider, there is a prudent process that plan sponsors should consider when thinking about adding a managed account solution as a QDIA or as an in-plan retirement income option.

According to a memo published by Groom Law Group, a prudent process includes:

  1. Gathering relevant information
  2. Considering all available courses of action
  3. Consulting experts where appropriate
  4. Making a reasoned decision based on all relevant facts and circumstances.

Sepsakos says “gathering relevant information” means ensuring that the plan document authorizes the appointment of a managed account provider, as well as ensuring that it makes sense to hire someone to provide managed account services based on the plan’s demographics.

Understanding the reputation of the providers in the marketplace, as well as their investment philosophies and strategies, is also important because some providers will take a more active management strategy than others who may be more focused on a glidepath, Sepsakos says.

“I think it’s important to understand what type of data is being used to help populate an investment plan for participants, and the fees are obviously super important, both direct and indirect,” he says. “Any conflicts of interest that the provider might have is also important to think through.”

Lastly, Sepsakos says it is important to compare and contrast providers against each other in order to fully understand the options available and how the quality of services differ.

“I think the marketplace is evolving,” Sepsakos says. “I don’t know that there’s been one solution that’s taking the industry by storm, but [I’m] seeing more conversations around whether or not managed accounts might be something for sponsors to think about. I think that’s reached that level of market saturation that you’re seeing much more [now] than maybe five, six years ago.”

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