As the defined-contribution industry and lawmakers continue their quest to retrofit 401(k) plans to replace pension plans, the biggest hurdle awaits — retirement income.
There is already a solution for the savings problem, or accumulation. That has been solved by using automatic enrollment at a healthy deferral rate and automatic contribution escalation, stretching the match and using professionally managed investments like target-date funds or managed accounts as the default. That, so far, has been the extent of the so-called “DB-ization” of DC plans. We still need to convince more plan sponsors about the merits of retirement income options, which is not easy. But it is much easier than convincing 90 million participants individually.
Solving for the distribution side, with a guaranteed stream of income to beat inflation and longevity risk, requires all hands on deck. Getting multiple parties to row in the same direction is difficult, especially when there are competing interests.
And while wealthy participants can engage with a financial adviser to craft and guide a retirement plan, less than 10% of the 401(k) and 403(b) population can afford traditional, one-on-one financial planning. The Secure Act could help address that.
The workplace is the best place to help employees with financial issues, even beyond saving for retirement. Starting to move assets into a retirement-income strategy within a DC plan as people get older makes sense — there are assets, data, access and fiduciary protection. So why have valiant attempts by many DC providers failed?
Let’s start with portability. When a plan or even a participant moves to another provider that will not or cannot take on the retirement income assets in its record-keeping system, they are left outside the plan. The Secure Act allows for a distribution to individual retirement accounts from in-plan retirement income, but that’s clunky, especially when it makes more sense to aggregate, not disperse, assets.
There’s also little incentive for DC plan sponsors to take risk. The Secure Act alleviates a bit of that risk by allowing current due diligence of an annuity provider to prevail, even if they fail in the future. But there’s other risk.
“Increased fees are a hot-buttons [issue] for litigators even if there’s value,” said Lew Minsky, executive director of the Defined Contribution Institutional Investment Association.
And who wants to go first? Retirement plan advisers will demand new product when clients push them, not the other way around. The DC industry will never make the next edition of “Profiles in Courage.”
Then there are low interest rates.
“Who wants to lock down low returns right now, foregoing healthy market returns?” said Tim Rouse, executive director at the Spark Institute.
There are also more subtle impediments.
“Broker-dealers have no incentive to keep assets in the plan,” said consultant George Revoir, a former senior executive at John Hancock. “There’s no revenue sharing and soft dollars like with IRAs, and no fees from custody, sweeping and securities lending.”
Is there demand? Record keepers would like to keep assets in the plan for obvious reasons. Plan sponsors are open to keeping assets of former employees in the plan, as long as the work and liability involved are mitigated. RPAs who do not have a robust wealth management and rollover angle, which is most of them, would also benefit.
Participants would appreciate more certainty, especially as they get close to retirement. DB plans pool risk, but each DC participant is managing their own personal pension plan. Joining a greater group at work using a record keeper with tens of thousands of plans that hire — and fire — insurers at a better rate is more attractive and cost-efficient.
Even though plan sponsors can mitigate risk under the Secure Act if an insurer that seems viable today goes bankrupt in the future, it only means that the risk is transferred to participants. After the Great Depression, the government had to use the FDIC to get people to start trusting banks again. The Pension Benefit Guaranty Corp. protects defined-benefit assets of failing companies. It could make sense to have a government agency funded by annuity companies that want to create in-plan retirement-income products to provide similar protection.
Is there hope for in-plan retirement income anytime soon? Probably just that — hope. The most likely near-term solution will be target-date funds and managed accounts that invest in annuities as people get older. Longer term, as RPAs create robust financial wellness for those who cannot afford wealth management, retirement income will be one of many services offered in collaboration with record keepers and annuity providers.
As our second lead editor, Cindy Hamilton covers health, fitness and other wellness topics. She is also instrumental in making sure the content on the site is clear and accurate for our readers. Cindy received a BA and an MA from NYU.