The Employee Retirement Income Security Act of 1974, or ERISA, hasn’t done much to specifically address retirement income security in defined contribution savings plans. The United States isn’t alone in this regard. Australia’s superannuation DC system hasn’t yet solved the problem of running out of money in old age.
Will giving plan sponsors a safe harbor provision in the Setting Every Community Up for Retirement Enhancement Act of 2019, or Secure Act — which allows them to have some fiduciary flexibility with respect to annuities — herald a new generation of investment solutions that provide true lifetime income security? Or will it open the floodgates to an unwashed horde of complex and expensive products that provide little benefit to workers?
Most plan sponsors, 62%, cite fiduciary risk as a barrier to implementation, and another 69% say that administrative issues such as portability prevent them from adding annuities to a plan, according to a 2019 survey by Willis Towers Watson.
The recently passed Secure Act significantly lowers the fiduciary risk of adding an annuity to a plan via a safe harbor and opens the door to no-cost annuity portability by participants. This should finally provide the 60% of surveyed plan sponsors who said they’d consider adopting lifetime income solutions with a pathway to begin adding annuities to their plans.
Employers want to provide employees with solutions for turning savings into income without leaving the security of the employer-sponsored 401(k) plan.
What impact will including annuities in retirement plans have on workers? Will the trend toward lower costs be reversed when the invisible hand of fiduciary liability is lifted for a class of products that generate the highest number of consumer complaints to FINRA?
Or will the addition of annuities pave the way for the next phase of the defined contribution revolution by finally giving employees an efficient way to turn their savings into a lifestyle?
The non-ERISA 403(b) market is a “living, breathing” example of what happens when annuities make their way into retirement plans without adequate regulation, according to Barbara Roper, director of investor protection for the Consumer Federation of America.
Some 80% of all investments are held in annuities in 403(b) accounts now, and 33% of total assets are held in oft-maligned variable annuities. The 403(b) plan is viewed as a “living hell” and the “most exploitative retirement system on the planet” by Anthony Isola, a financial advisor with Ritholtz Wealth Management.
But 401(k)s may be different. Plan sponsors have developed a far more paternalistic, fiduciary mindset and are wary of adding any potentially uncompetitive options to a plan menu. Not to mention the challenges of getting a recordkeeper on board.
“The difference with the 403(b) market is twofold,” said Fred Reish, a partner at Faegre Drinker Biddle & Reath and an ERISA expert. “A retail agent can sell directly to the individual investor. With 401(k) plans, they have to get on the recordkeeper’s platform. It’s just a different vehicle than an individual sale that marks the schoolteacher 403(b) marketplace.”
The Secure Act provides safe harbors when it comes to the selection of the insurance company to be included in 401(k) plans, but it also has a provision stating that fiduciaries are required to evaluate costs, according to Reish: “This could bring the same kinds of pricing pressures that are applied to mutual funds. If people think there’s going to be traditional kinds of retail annuities in plans — I don’t know if that can happen.”
Fear and speculation about the possible invasion of variable annuities into 401(k)s seems a bit overblown to Kevin Hanney, senior director of Pension Investments at United Technologies Corporation. UTC, one of the largest employers in the United States, already uses a variable annuity with a guaranteed income withdrawal benefit rider. And they don’t just use it as a core menu option for a few participants — a variable annuity is the qualified default investment alternative (QDIA).
UTC implemented the VA over seven and a half years ago, and the plan has over $2 billion invested by some 47,000 employees — all within an ERISA environment.
The UTC Experience
A recent AllianceBernstein survey found that 69% of employees list “a steady stream of income” as a top feature they would like to see in their retirement plans, and almost 90% would keep some or all of their contributions in a guaranteed-income target-date fund if their employer automatically enrolled them in it.
“I would say that United Technologies did not set out to pick an annuity. They set out to pick the key criteria,” explained retirement expert Mark Fortier, who was head of product and partner strategy at AllianceBernstein during the development of UTC’s QDIA.
“They wanted a default, certainty of income and control over the money (liquidity). They wanted to address the fact that a loss of control and risk aversion were real forces that they had to respect, and they wanted a simple enough experience that the only choice for participants was ‘when do I take the income?’ The variable annuity just happened to fit the needs of certainty and control,” said Fortier.
A traditional QDIA is built for accumulation but does not offer a pathway to decumulation. There is plenty of control, which is fine for sophisticated participants who feel comfortable investing and withdrawing from the account for income.
But to an average participant, especially one accustomed to the idea of receiving a pension in retirement, the 401(k) offers little in the way of clarity. Workers don’t know if they have enough to comfortably retire.
“There’s nothing wrong with keeping them in the traditional QDIA. But you can put them in something better. As a fiduciary why wouldn’t you? That’s my attitude,” noted UTC’s Hanney.
In developing the lifetime income solution for UTC, he faced the common resistance of plan consultants: “I’ve been in meetings where we have been talking to a plan sponsor who believes in the importance of including some sort of a guaranteed income option, and the consultants have been saying, ‘No, no, no, that’s too risky.’ There’s no upside for the employer and there’s a lot of potential downside,” he explained.
The idea that employers don’t benefit from offering a default retirement plan with guaranteed income is dismissed by Hanney. “Any consultant that says there’s no upside for the employer is wrong,” he said. “You’ve now created the feature that gives your workforce the option to retire according to their own schedule.”
An employee who looks at their 401(k) statement and sees a lump sum number that can’t be translated into income may feel uncomfortable moving into retirement. And there is a price to pay for keeping workers at their job when they’d rather be retired.
“When you start to add up the hard and soft costs of someone who’s effectively retired at their desk, that’s very expensive to the employer,” according to Hanney.
The UTC pension chief also had the advantage of working with experts to design a retirement income product that fit the needs of UTC’s workers as they transitioned from a traditional defined benefit pension. UTC created a consortium of three insurers to reduce price and capacity risk, and it worked hard to keep pricing in line with other lean QDIA options.
Although sponsors of small firms may not have the same research muscle, insurers can work collaboratively with plan sponsors, consultants and recordkeepers to develop creative DC solutions designed for the unique needs of an employer’s workforce.
The Rollover Problem
In the United Kingdom, the Financial Conduct Authority recently admonished nearly 2,000 financial firms for recommending the transfer of assets at retirement out of defined benefit income and into managed portfolios from which the firms derived compensation. According to the U.K. regulator, “We expect you to start from the assumption that a pension transfer is not likely to be suitable for your client.”
Billboard ads have been put up outside UTC facilities by “IRA poachers,” Hanney says, trying to get employees to pull savings out of their guaranteed income QDIA and to “put your money back where it belongs.”
Economists consider a TIAA variable annuity to be among the most efficient products for creating a protected lifetime income that can rise with equity performance. Yet a recent study found that annuitization among TIAA participants fell from 50% to 19% over the last 20 years.
One possible explanation for this decline is the often self-serving discreditation of annuitization by those who get paid to manage assets that would otherwise be turned into lifetime income. Should an annuity be the default choice for all retirees?
In the United States, most defined contribution plans do not contain any automatic annuitization into a defined benefit-type lifetime income plan. The vast majority of assets rolled over from a 401(k) to an IRA are either self-managed or managed by advisors who are compensated by either the sale of investment products or through ongoing asset management fees.