Without Lifetime Income Solutions, Participants Tend to Withdraw Too Much

Without having explicit lifetime income insurance, more than one-third of defined contribution plan participants may run out of money in retirement, according to a new report from AllianceBernstein.  

But due to a lack of financial literacy and misconceptions about what level of withdrawal rate can be sustained over time, many participants are hesitant about purchasing lifetime income products and greatly overestimate how much of their nest egg they will be able to spend yearly without running out of money, AB’s “Leveling the Retirement Income Playing Field” found.  

AB asked in its latest plan participant survey, Inside the Minds of Plan Participants, what percentage of their retirement savings participants would spend yearly if they retired at age 65 and had $500,000 in their retirement account, with the goal of not running out of money for the rest of their life. 

More than half (57%) of participants thought they could withdraw 7% or more annually (or said they did not know how much they could withdraw), with almost one-third responding that a withdrawal rate of 10% or more was sustainable. 

“These unwittingly high withdrawal rates may cause participants to run out of money early in retirement, even in good market conditions,” the report stated.  

AllianceBernstein’s report argued that the yearly withdrawal rate with $500,000 in assets should be as low as 2.3% to ensure a near-certainty of not outliving their savings. 

Hesitancy to Purchase Lifetime Income 

Many participants worry about the “strings” attached to lifetime income products, specifically those that include insurance. For instance, 39% of survey respondents said they were most nervous about inflation eroding the purchasing power of an income stream if they purchase one. 

Additionally, 21% of respondents said they were most worried about giving up control of assets and having a lack of access in case of emergency, and 13% said they were most worried that if they die earlier, they will lose the income benefit they paid for.  

When it comes to annuities, many participants reported they were scared to surrender a large portion of their assets and lock that money away. The Inside the Minds of Plan Participants survey illustrated a desire for liquidity and asset ownership. 

For example, the survey asked respondents to choose between having $50,000 in guaranteed annual income, but their money would not be invested in the stock market and they would not have access to the principal in their account, and having $40,000 in guaranteed annual income, but the money could grow in the stock market and they would be able to access the money in their account.  

Approximately two-thirds (68%) of respondents chose the $40,000 option to keep ownership of their assets and maintain the potential for asset growth in rising markets.  

Benefits of QDIAs 

AllianceBernstein’s report argued that incorporating insurance into a participant’s asset allocation may improve sustainable withdrawal rates by 70% or more. The most effective way to deliver insurance is as part of a qualified default investment alternative, the report found, and doing so can “reduce stress for plan participants and improve workforce management for plan sponsors.” 

Not only does a QDIA relieve participants of their “portfolio management” responsibilities, but AB argued that incorporating lifetime income into a QDIA offers other benefits, such as keeping the assets in the plan. As a result, this might give the plan more leverage to negotiate with providers than individual participants would have on their own.  

This automatic method of implementing lifetime retirement income resonated with most participants. A survey conducted by Invesco, cited in AB’s research, asked participants how they felt about their employer automatically enrolling them into a retirement income option, assuming they could opt out with no penalty when they receive the notification, and approximately 80% of respondents were in favor. 

What Plan Sponsors Can Do 

To help plan sponsors create a “level playing field” and provide more access to lifetime income solutions, AllianceBernstein provided a framework for plan sponsors to compare different methods of delivering sustainable income throughout retirement. 

The firm recommended that plan sponsors “assess the individual, not the average participant.” Because potential market outcomes and lifespans for DC participants are not smoothed over multiple people as they are in defined benefit plans, this could produce vastly different individual investment outcomes. 

It is also important for plan sponsors to measure the total costs of lifetime income solutions, not just explicit fees, the report stated. Balancing these costs against the benefits each solution provides can help plan sponsors determine if a certain product is suitable for their population of participants.  

Lastly, AB advised that plan sponsors apply a comprehensive analysis encompassing income, account balances and major risks participants face—such as market risk, growth risk, inflation risk and longevity and mortality risk—to enable a holistic comparison of solutions.  

The Inside the Minds of Plan Participants survey was conducted in April 2023 and had more than 1,200 respondents.