Generating income in retirement remains one of the Holy Grails of investing. For plan sponsors looking to design and implement robust offerings, the challenges are many, so PGIM brought together a panel of experts on June 18th to discuss those challenges – including demographics and an ever-changing regulatory environment – and offer up some potential solutions.
The discussion, Retirement Income in DC: Has the Time Come?, was the latest in PGIM’s popular Best Ideas Series, invitation-only, educational seminars designed specifically for senior decision makers for institutional pools of capital. It was held at the University of Chicago’s Gleacher Center, part of the Booth School of Business. The panel was made up of two PGIM associates – moderator Josh Cohen, Managing Director, Defined Contribution, for PGIM’s Institutional Relationship Group, and Jeremy Stempien, Principal and Portfolio Manager and Strategist for QMA – along with Joe Fazzino, Senior Director of United Technologies’ pension investment team, and Dennis Simmons, the Executive Director of CIEBA, the Committee on Investment of Employee Benefit Assets.
A portion of the discussion was centered around legislative developments in Washington, including the Retirement Enhancement and Savings Act (RESA), intended to increase and enhance employees’ retirement savings. RESA was actually unanimously passed by the Senate Finance Committee back in 2016, and in May, the SECURE Act of 2019 (Setting Every Community Up for Retirement Enhancement) passed the House by a vote of 417-3. That legislation incorporated key aspects of RESA and included additional provisions, among them:
- Increasing the age requirement for required minimum distributions to 72 from 70.5
- Encouraging small-employer plan adoption
- Requiring participation eligibility for long-term, part-time employees
- Offering options for portability of lifetime income
The legislation also requires of plan sponsors a lifetime income disclosure, with a monthly annuity income estimate on annual benefit statements, and offers a fiduciary “safe harbor” for the selection of a lifetime income provider if the fiduciary receives representation that the insurer meets state insurance laws.
Whether or not any of this becomes the law of the land, of course, is anyone’s guess.
“Retirement legislation kind of reminds me of Sisyphus,” Simmons said. “They push the rock up the hill only for it to come back, then they push it up again and it comes back again. The devil is in the details but hopefully this legislation gets over the hump.”
Why it’s so Important
Over the past decade there’s been a substantial change in some of the fundamental aspects that impact both employees and plan sponsors. Workers are clearly becoming more dependent on DC plans, and Cohen said that, according to the U.S. Bureau of Labor Statistics, in 2010 the median age of the workforce was 37.2 years, while in 2018 it was 42.2. He also noted that plan sponsors are showing far greater appreciation for financial wellness, with one study showing that in 2018 65% of sponsors say that’s something they focus on, versus just 30% in 2014.
“Financial wellness is about a lot of things, but effectively it’s saying, ‘If I have a workforce that’s less financially stressed and more retirement ready, it’s not only good for the employee but it’s also good for the company,’” Cohen said.
It’s also true that the cost of delayed retirement for corporate America is expensive. Citing Prudential research (Why Employers Should Care About the Cost of Delayed Retirements), Cohen said a one-year delay in retirement can lead to employers paying an extra 1.2% as a percent of total workforce costs. A two-year delay results in a 2.2% increase, and the impact of a three-year delay reaches 3%.
A Real-World Example
Like most companies, United Technologies (“United Tech”) has been moving away from a defined benefit (DB) plan to a defined contribution (DC) plan, undertaking a handful of projects over the past 15 years or so to reduce the firm’s exposure to a DB plan while building a flexible and forward-looking DC plan. Within that DC plan, United Technologies started offering a Lifetime Income Strategy (LIS) option in 2012, offering many features found in a target-date fund but with security of lifetime income. Of the company’s $28.1 billion in total savings plan assets, Fazzino said close to $2 billion is currently housed in the LIS bucket, and 44,000 of its 115,000 plan participants are in the LIS program.
“It looks a lot like a target-date fund, investing in a mix of growth assets but then gliding into a portfolio of variable annuities that have certain riders that make it look a lot like a DB benefit within a DC plan,” Fazzino said. “By the time our participants are 60, their entire LIS portfolio is held in variable annuities that have been purchased over time since they were 48. That’s important because you’re buying the annuities through different interest rate cycles.”
The LIS is guaranteed through a multi-insurer structure. Fazzino explained that United Technologies has a quarterly auction process for the three insurers that participate in the product. They bid on the block of business, which is age and cohort specific, that most appeals to the insurers at that time. For example, in any particular quarter Insurer A may only be interested in winning the 49-year-old block of business, while Insurer B may have more of an appetite for the 60-year-old block, so each may bid more aggressively for what they’re looking for. Fazzino said United Technologies has purchased close to $600 million of insurance from the three providers that back its LIS.
Evolving Solutions and Strong Communication
Constructing a more retirement-income-friendly plan is about more than offering a specific product. Cohen noted that plan design is an integral part of any strong DC program. If DC 1.0 was a do-it-yourself plan, and 2.0 was built around enhancing participation and diversification to support accumulation, what he calls DC 3.0 is designed to help people really think about lifetime income.
What might DC 3.0 look like? Here are some features:
- Setting retirement readiness objective and measuring results
- Setting default and match formulas based on objectives
- Allowing for systematic withdrawals in addition to lump sums
- Default driven and professionally managed solutions pre- and post-retirement
Cohen said enhanced communication plays a vital role in DC 3.0. More than simply focusing on accumulation, plans need to communicate to participants their balances in terms of projected retirement income and offer tools and advice on how they can meet retirement readiness goals and spend down in retirement.
Stempien said part of the solution lies in a glidepath design with a retirement readiness objective, with guaranteed income to hedge against unique risks, especially longevity. Technology can also be used to provide more tailored advice and solutions.
“There are plenty of plan design features you can implement to support lifetime income,” Stempien said.
To address one of the key risks that many standard target-date funds don’t necessarily account for – longevity – Stempien suggested the use of a Qualified Longevity Annuity Contract (QLAC). A QLAC is an annuity-like product that guarantees lifetime income, which can be deferred up to the age of 85.
“A QLAC addresses the tail risk people have in their lives,” he said. “A lot of surveys suggest that people are more worried about running out of money than they are about death. A QLAC can help address the idea that if someone is fortunate enough to live long they should view that as lucky and not unlucky because they don’t have any more money.”
Another risk related to retirement income rests in interest rate exposure. Many participants can accumulate a substantial amount of money for their golden years, but that pool may not be built to weather certain interest rate environments. To address that, investors may consider key rate duration targeting, matching a handful of different fixed income funds with different durations.
“Our goal is to make sure people can spend in retirement for 30 years, but just giving them the widgets isn’t enough,” Stempien said. “Plans have to do some hand holding to make this a success.”
Putting it all together
changes that may or may not come out of Washington, it’s incumbent upon plan sponsors to help participants meet their long-term needs.Much of thefocus up to this point in the DC industry has been on helping individuals accumulate enough assets to achieve their retirement goals. However, this is solving for only part of the challenge as participants will be faced with new risks in meeting their retirement spending needs. With discussions around retirement income within DC plans gaining momentum, now may indeed be the time for sponsors to make meaningful enhancements to their plans to support retirement income.
More About Best Ideas
PGIM’s Best Ideas Series is targeted to CIOs and other C-level decision makers, and is intended not only to broaden attendees’ knowledge, but also to help make connections. The meetings are conducted in an intimate, discussion-based setting, and the topics and discussions presented are focused on actionable investment ideas and issues relevant to decision makers with fiduciary oversight. For more information about these events contact Jamie Crosby at firstname.lastname@example.org.
Source(s) of data and as of date(s): 6/30/2019
Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. Investing involves risks, including possible loss of principal.
In providing these materials, PGIM is not acting as your fiduciary and is not giving advice in a fiduciary capacity. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The views and opinions expressed are as of July 2019 and may change as subsequent conditions vary. The information and opinions contained herein are derived from proprietary and non-proprietary sources deemed by PGIM to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by PGIM, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.
PGIM, Inc. (“PGIM”) is the primary asset management business of Prudential Financial, Inc.(“PFI”) and is a registered investment adviser with the US Securities and Exchange Commission.
© 2019 PFI and its related entities. PGIM, the PGIM logo, and the Rock symbol are service marks of PFI and its related entities, registered in many jurisdictions worldwide.