(August 1, 2013) – Guaranteed retirement income: members want it and plan sponsors want to provide it. Still, at present, both have been left wanting.
“Innovation is difficult in DC [defined contribution] because every element needs to work in tandem,” Fredrik Axsater, State Street Global Advisors’ (SSgA) head of defined contribution, told aiCIO. “The product, the plan’s infrastructure, counterparty risk, regulation, and operational factors like record keeping and communication with participants must all line up.”
One such key feature relates to plan design. “If you’re trying to help the majority of participants, an income product almost has to be part of the default option,” Axsater said. “It can’t be too difficult for members.”
Roughly 70% of US DC scheme members stick with the options they’re handed, according to Axsater. That tendency may be the solution to the “annuity puzzle”—a well-documented phenomenon which has stumped many a researcher. Studies and market data have both borne out this puzzle: People consistently choose lump sums over annuities, even if the expected payout of the latter amounts to much, much more.
As the DC industry has learned, you can lead a retiree to TIAA-CREF or MetLife, but you can’t make it purchase an annuity.
But, according to SSgA data, low rates of retail annuity purchase have not stemmed from weak demand for retirement income.
Indeed, a stream of income during retirement was a top priority for the 1,498 DC plan members the firm surveyed in April 2013. More than three-quarters (80%) of respondents—all aged between 40 and 70 years old—said a guaranteed monthly payout was a “must-have,” even if it meant sacrificing in other areas.
To most people surveyed, retirement income was not only a priority but also a necessity. One-third believed they would need a guaranteed income source in addition to Social Security. The expectations of this cohort were not lavish: 46% planned to retire after the age of 66.
"What we've never seen before until this research is participants' understanding of the tradeoffs: liquidity for income security, flexibility for longevity coverage," Axsater said. "Ultimately, I believe the best outcomes will come from a balance of both."
SSgA also interviewed approximately 40 plan sponsors about their needs, preferences, and appetite for post-retirement income products.
“Interest has been very strong among my clients,” Axsater said. More than 90% of plan sponsors interviewed said monthly distributions would be “ideal,” and worth sacrificing some liquidity for.
While members and sponsors’ priorities aligned on most aspects of income stream design, inflation risk was not one of them.
“Not a single plan sponsor said they would be willing to trade inflation adjustment for increased initial income,” Axsater recounted. The majority of members were happy to take the risk. “Most of the respondents”—whose age averaged 56—“would not have first hand knowledge of what high inflation can do to a fixed income,” he said. “Inflation over the last 10 to 20 years has been very mild.”
Partial annuities will not be appearing on the average default 401(k) menu for several years at least, according to a number of DC experts. Logistical and regulatory hurdles aside, plan sponsors and financial firms have every incentive to proceed with extreme caution.
“It’s a hard space to experiment in—you have to be very sure and very deliberate,” Axsater said, noting that SSgA has made retirement income a priority. “Yes, we’re an institutional asset manager. But, really, it’s people’s retirements at stake.”
Related Content:More 401(k) Options Mean Worse Outcomes & Why People Don't Buy Annuities: They’re Confusing.