For more than a decade, providers of defined contribution plans have been trying to solve the real challenge of retirement income. 401(k), 403(b), and 457(b) programs have been tremendously successful in helping participants (those with access to these plans) accumulate significant assets for retirement. The proliferation of automatic plan features like automatic enrollment, automatic escalation, and target date funds have further improved the effectiveness of these plans, yet for most plans in the U.S., there are no options for generating lifetime income inside the plan.
It would be difficult to argue that guaranteed income wouldn’t improve the efficiency of delivering retirement security in the aggregate. At the very minimum, most retirement income solutions allow users to pool longevity risk, where defined contribution account holders have to individually underwrite the possibility of living past their 100th birthday.
Data also strongly suggests that participants with guaranteed retirement income benefits are able to enjoy their retirement better, knowing that without regard to the performance of markets, their next retirement “paycheck” will show up.
It is further true that cognitive risk associated with investment and portfolio management increases with age and that guaranteed retirement income for some of a portfolio greatly reduces these risks.
So, at a very foundational level, guaranteed retirement would appear to be a necessary component of any retirement plan. Why is retirement income a rare feature within plans and even when available, utilization among participants is minimal
Let’s start with what isn’t stopping progress.
Regulatory Protection. Many in the industry believed that if reasonable safe harbors were created for plan sponsors, plan sponsors would respond with fast action to make guaranteed retirement income available in their plans. That hasn’t been true and probably shouldn’t have been expected.
For years, plan sponsors have been stepping up to meet the needs and requests of their participants without regard to the state of regulatory guidance. In the last five years, we have seen the adoption of:
- environmental, social, and governance (ESG) focused investments in retirement plans
- integrating student debt repayment with retirement plan features
- discussions of cryptocurrency investments
(all in advance of or directly in conflict with Department of Labor guidance at the time.)
In a panel presentation I participated in immediately after the passage of the SECURE Act, I predicted correctly that the movement of ESG integration in investment menus would move much more quickly than retirement income and that’s because governmental protection was never the problem, employee interest is.
My choice of word is an important one (employee versus participant). Most retirement plan committees (made up of employees) are focused on attracting and retaining a high-quality workforce. In this capacity, they are understandably focused on what features and benefits the plan has for current employees to make them more attractive as an employer.
By contrast, who is interested in guaranteed retirement income? Former employees. And former employees have unlimited options about what to do with their retirement savings. They are endlessly solicited on TV, social media, and periodicals with financial service firms eager to help them transition into retirement. It is unlikely they would even bother asking their former employer to provide more assistance, they would go find it where they could.
So why, when retirement income solutions are available in plans, are they used so infrequently by participants? Trust.
First, participants don’t trust their own knowledge of the options available to them and are understandably concerned with making a bad and potentially irrevocable mistake. Every month publications in the retirement plan space will report that most participants using target date funds don’t understand how those funds work, thereby implying that participants perhaps should not use them.
However, in my more than 20 years in the retirement plan space, I have yet to meet a single participant that understood a flexible premium or single premium deferred or immediate annuity, or a guaranteed minimum withdrawal benefit. There are good products available and likely more to come, but if participants lack the confidence to select a product and deploy assets the effort in extending the option is wasted.
This leads us to the last trust deficit, those charged with helping participants understand and effectuate retirement income. While there are good products available (see above), there are also terrible products available. There is an inverse correlation between the quality of the product and the compensation that an organization or person may receive from selling it.
There are good and earned reasons for retirement plan participants to distrust those seeking to “help” them with retirement planning. The depth of this mistrust may be difficult to bridge.
In our industry, much focus is given to large class action cases brought against plan fiduciaries relative to recordkeeping costs or investment performance. Still, the largest breaches of trust I’ve ever witnessed in my career are individual transactions between participants eager for help and bad actors in the investment industry expert at selling bad products that pay well.
These individual breaches are too small to be written about in the media but are far more damaging to a former employee and their family than most fiduciary class action cases I’ve seen.
There is much work to be done to create a safe foundation for the mass adoption of retirement income solutions in defined contribution plans and getting the education in place is first among them. We continue to see the industry get retirement education wrong. Retirement education focused on explaining the benefits of compound interest has been routinely shown to be ineffective. Use the automatic tools available to get participants enrolled and allocated. Let them build a life and develop a career. They have a long time to learn what they need to about how retirement plans work. Education needs to focus on engaging with older employees who will need to make good decisions about what to do with their retirement accumulations. Should I keep my money in the plan? If I leave the plan, how do I decide if I need help in managing my retirement strategy? If I need help, how can I find a reputable partner that acts in my interest? How does social security work and when should I take it? What about my medical needs?
These questions can’t be fixed by changing the design of the plan, they can only be addressed by engaging employees and empowering them to make good decisions.
Retirement income is coming, but the work to facilitate its utilization should not be underestimated.
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.