Welcome back to Human Capital! This week, we’re checking in with David John, senior strategic policy advisor at AARP Public Policy Institute and a nonresident senior fellow in economic studies at the Brookings Institution, to drill down on two papers he recently co-wrote on ways to deliver retirement income.
Should all retirees use annuities? That’s one question John and the other retirement experts tackled in their first paper, When income is the outcome: Reducing regulatory obstacles to annuities in 401(k) plans. The second paper, From saving to spending: A proposal to convert retirement account balances into automatic and flexible income, continues that theme and posits that a “default decumulation solution” via managed payout funds may be a more suitable option for some folks. The sticking point: making them widely available in retirement plans.
“The conventional wisdom is that everyone should be in an annuity, but in the managed payout out paper we address the question: Is that the right vehicle for everyone?” John told Human Capital.
What’s a managed payout fund? John and his colleagues describe it as “a major alternative to an annuity,” stating the diversified pool of investments is designed to produce a relatively consistent level of annual income but, unlike an annuity, doesn’t provide a guaranteed outcome.
The funds are similar to target date funds (TDFs) “but have a different objective,” John and his colleagues say, in that TDFs typically invest in a mix of asset classes, including diversified equities and bonds.
Distributing income “is not necessarily” TDFs’ objective, whereas managed payout funds serve as “decumulation vehicles, paying monthly or quarterly cash distributions to retirees.”
Managed payout funds’ strategy: “To generate regular investment earnings and gains for income with carefully managed risk to reduce losses,” according to John.
The funds act as a “default decumulation solution that could be added to retirement plans to simplify decumulation choices” much like auto-enrollment, contribution and investment allocation decisions have worked for savers.
The goal is to use managed payout funds to deliver monthly income “that is likely, though not guaranteed, to last a lifetime,” according to John, coupled with longevity annuities that begin to make payments when the owner reaches an advanced age.
The problem: The funds are offered on a retail basis but not through employers.
One remedy: the Labor Department changing its qualified default investment alternative regs so that a managed payout fund could be a default investment.
The paper explores how to provide an “automatic solution that converts savings” into income. “But we wanted something that was flexible, different [so retirees] could make a change without a cost or high complexity” that comes with an annuity.
Said John: “If you’re defaulted into the traditional single-payer annuity, first there’s a question of ‘how much do you put in it?’ Second, there’s a question of ‘what if it’s not the right solution for you?’ Surrender values tend to be very high, in other words, you’ve got a lot of fees to pay.”
The perfect candidate for a managed payout fund is the middle-income retiree. “A retiree who needs the income other than Social Security but is not likely to have the same sophisticated guidance and advice that you’ll see with upper-income individuals.”
Must the Labor Department alter QDIA regs before managed payout funds are available via employers? “Not necessarily,” according to John. Three “well-known ERISA attorneys” had differing views, but some TDFs “could be structured so that at retirement, the retirees’ assets are shifted automatically into the equivalent of a managed payout fund.” If this is the case, “it should be allowable under current regulations and laws, and the employer would choose such a structure.”
Another solution: a separate managed payout fund “that the retiree’s assets would be rolled into either all at once at retirement or over time starting several years before retirement,” John said. “Whether this would be allowable needs to be clarified.”
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