David Blanchett, Morningstar Investment Management LLC
Sponsors of defined-contribution plans who want to help participants after retirement have several key considerations to weigh. Here are a few that are unique to the distribution of retirement benefits:
- Keep the connection. You’ve been a great resource to your employees by providing an economical and efficient way to help them save for retirement. Keep it going by allowing them to continue to use the defined-contribution plan as a vehicle for their retirement needs:
- Lower cost: From a fee perspective, your employees may not be able to do better than what you’re providing them through the buying power of the plan’s retirement benefits.
- Sound advice: A managed accounts service can offer comprehensive, customized distribution recommendations to participants. This could include appropriate recommendations to an annuity, if that’s available in the plan and in the best interest to the participant.
- Retirees help current employees: Administrative costs are typically priced as a per-participant fee, and investment expenses are typically asset-based fees. In both instances, having retirees in your retirement benefits should help lower both the administrative and investment expenses because more people in the plan tends to lower average administrative expenses. Plus, retiree balances tend to be larger than active employees.
- Keep it real. The goal of many retirees is to generate some amount of income during retirement, increased annually by inflation. Therefore, inflation is a very important consideration when working toward this goal. Real assets, or asset classes that generally rise with inflation, can be valuable investment options for retirees. Some examples of common real assets include Treasury Inflation-Protected Securities, real estate, commodities, etc. For some plans, it may make sense to consider a single, multimanaged “real asset” option to provide participants with a one-off way to gain exposure to real assets.
- Consider guaranteed income for life. Retirement may end up being 30 years or more. Generating income for such an extended period is no easy feat, especially given today’s low bond yields. So, including some type of guaranteed income option in a defined-contribution plan is an important consideration. But it comes with interesting fiduciary considerations. Here are some things to keep in mind:
- Keep good records: Members of your plan’s investment committee may come and go, but an annuity is designed to last forever (or at least 30 years). So, it’s essential to keep detailed records of the due diligence procedures for selecting and monitoring any type of plan annuity option.
- Portability: How are participants who want to roll out of the plan affected? Portability is important, given participant behaviors, especially if the participant has paid for some type of guaranteed benefit and loses this insurance if he or she rolls out of the plan.
- Peel back the onion: Annuities can be incredibly complex vehicles and come in many shapes and sizes. Plan sponsors should really understand what they’re buying and how it might be able to fit the needs of their participants.
- Bring in the expert: Given the complexity of the annuity decision, it makes sense to seek counsel from experts. While many plan sponsors may be comfortable using various quantitative tools for screening traditional investment options for their retirement benefits, such tools don’t really exist in the guaranteed income space.
- Gauge the true cost: Annuities, as a form of insurance, should not be expected to result in a positive value for the average participant. While some participants will be better off purchasing an annuity than investing the money themselves in a portfolio and taking withdrawals, insurance companies are in business to make a profit and are generally quite good at pricing risk. Understanding these costs and how they affect different participants is an important in the selection and monitoring process.
- Participant experience: The final consideration is participant communications and the participant experience when owning and using the guaranteed income option to fund retirement. One size does not fit all, so different guaranteed income options are likely to work better for different types of defined-contributions plans.
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