21 May. 2013 | Comments (0) Share Follow @Conferenceboard
Last November, I wrote a post on income replacement during retirement called Focus on Helping Employees Build a Paycheck Replacement in Retirement. In this post, I wish to highlight the results of a report from The 2012 ERISA Advisory Council, which studied the topic, “Examining Income Replacement During Retirement Years in a Defined Contribution System.” The report sets forth the council’s analysis and provides insights into retirement today, as well as offering several recommendations to the Department of Labor.
The recommendations to the Department of Labor (DOL) cover regulatory guidance, employer outreach and education, and public outreach and education. The Council recommended that the DOL consider regulatory guidance or clarification with respect to a defined contribution plan annuity safe harbor, participant education, and investment advice. They stated that, “The guidance/clarification should be designed to reduce current barriers faced by fiduciaries, plan sponsors, and service providers in their efforts to encourage participants to develop post-retirement income strategies and to consider alternatives in offering income replacement options.”
These recommendations also suggested immediate clarification in the form of sub-regulatory guidance (where feasible) to help sponsors and administrators move ahead. My last blog on this topic also offered a range of alternatives for plan sponsors to consider as they support paycheck replacement.
The Council identified a number of topics that might be covered in education for employer and plan sponsors:
- “The need to accomplish a shift in the perception of defined contribution plans, to include the importance of the decumulation (retirement distribution) process;
- Commonly applied definitions;
- Features, designs, risks, and trade-offs;
- Roles of a plan sponsor/employer when offering income replacement options, education, and advice;
- Review and evaluation of projection tools used for income replacement stream; and
- Lessons from behavioral finance and research about misconceptions related to income strategies, planning horizons, and understanding of longevity risks.”
The Council also identified a number of topics that might be covered in education for participants.
- “The importance of understanding the life-cycle approach to planning;
- Key features, designs, risks, and trade-offs;
- The importance of understanding the tools and assumptions used to project income stream;
- The need to evaluate all household sources of retirement income, including survivor benefits and Social Security;
- The impact of inflation and inflation assumptions;
- Understanding the impact of longevity and longevity risk, the need for a long planning horizon and potential benefits from mortality risk pooling; and
- The timing of decisions and alternatives.”
The Council discussion also focuses on the importance of default options, and the possibility of safe harbors for some defaults. My view is that this is a critical topic, but there is no current consensus in the retirement community about defaults for income options, and this is an area that needs more discussion.
The Council also focused on barriers to plan sponsors facilitating income replacement options. Fiduciary responsibility is certainly a barrier and was discussed by several witnesses. I presented a summary of barriers as I see them in my article in the January 2013 Society of Actuaries Pension Section News.
The analysis in the report offers insights into fiduciary concerns, plan sponsor considerations, and participation challenges.
The GAO has recently been studying a related topic. Rollover of assets into an Individual Retirement Account is a popular strategy at time of retirement. However, rollover can be costly to participants. They lose the fiduciary protection of an employer plan, and in some cases, they end up paying significantly higher expenses from the IRA. These higher fees are particularly costly in a time of low interest rates.
Yet, many financial service firms have a strong interest in encouraging rollover into their retail products. A March, 2013 GAO Report, 401(k) plans: Labor and IRS Could Improve the Rollover Process for Participants, documents how rollovers are favored over plan-to-plan rollovers and other distribution options. The report also documents that plan participants have challenges in obtaining accurate and clear information about their distribution options and the trade-offs between them. Plan sponsors are encouraged to revisit their distribution processes, the support they provide, and the information that is delivered to participants.
I have several tips for employers:
- Remind employees to carefully consider Social Security claiming options. While the majority of people claim early, there is a lot of evidence that this not a good strategy for many people. The best strategy depends on individual situations.
- Help employees understand their expected life span, how variable life span is, and that some people will live to a much higher age. Society of Actuaries research shows that individuals often have too short a planning horizon and that they underestimate life expectancy. As an actuary, I have a mission to get more people to think longer term.
- Remember that employees are setting up a post-retirement financial and life portfolio. Many plan participants do not understand the major types of options and the trade-offs between them. Lifetime income may have a place in this portfolio, but often it is far preferable to choose lifetime income for a part of the portfolio only.
- Provide clear information about options and be very clear about the trade-offs, and what is guaranteed and what is not.
- Recognize the value of competitive bidding. A recent paper analyzed competitive bids and found that that spreads between the high and low bid can easily be 15 percent. It also found that the best bidder in one quote scenario would be the worst bid in others. Overall, plan participants get a better outcome with competitive bidding than with a single provider.
- Consider the purpose of your retirement program when establishing distribution options.
- Be sure you understand the financial incentives embedded in any distribution approaches and rollover products. Avoid approaches where the incentives of the provider are opposite to those of the plan participants. Give participants a list of questions to ask when they are considering specific products on their own.
Anna Rappaport served on the ERISA Advisory Council when the lifetime income topic was studied. The views in this blog post are solely the views of the author.
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