Over the past several years, U.S. employers have designed and implemented investment menus to help employees face the many challenges that accompany the continuing shift from defined benefit pension plans to defined contribution plans—a shift that places the responsibility for investing account balances during working years directly on employees.
But employers historically have given relatively little attention to the period during retirement, when retired employees are responsible for investing and drawing down their account balances, according to an issue brief from the not-for-profit Institutional Retirement Income Council (IRIC), which promotes retirement income solutions.
The issue brief encourages sponsors of 401(k) and other defined contribution plans to begin offering plan participants a limited menu of options to generate retirement income from their account balances.
“Unfortunately, most employees lack the time and skills to make effective decisions on generating retirement income from their account balances,” said Steve Vernon, president of Rest-of-Life Communications, a retirement education consulting firm, and author the issue brief, The Retirement Income Menu: An Idea Whose Time Has Come.
“Additionally, employees, faced with a bewildering array of financial products, institutions and advisors, typically make choices that may not best fit their situation, or are so paralyzed with fear that they don’t make any choice at all,” Vernon added. “A properly designed and communicated retirement income menu can go a long way toward helping retiring employees make the right decisions and generate reliable sources of lifetime retirement income.”
On the Menu
Under a retirement income menu, retiring employees would be offered a limited set of distinct methods to generate retirement income from their account balances, including:
• Traditional fixed annuities.
• Managed payout funds that will pay interest, dividends and principal over specified periods.
• Guaranteed Minimum Withdrawal Benefits (GMWBs) that offer a combination of invested assets with a guarantee of lifetime retirement income.
• Immediate variable annuities where the monthly benefit is adjusted to reflect investment performance of underlying mutual funds.
• Hybrid products that combine managed payouts with longevity insurance (annuities that begin at an advanced age, such as 80 or 85).
According to the issue brief, a combination of retirement income approaches might work best for a retiree’s specific circumstances and employees could distribute their account balances among more than one method of generating retirement income. For example, a retiree might take part of the account balance to purchase an annuity to address longevity risk and invest and draw down the remainder of the account balance to provide access to capital in case of emergencies.
In addition, the menu would include a lump sum payout and/or a rollover for employees who don’t want to use the retirement income menu.
“We see the retirement income menu as the next evolution in defined contribution plans," Vernon said. "Just as employers have implemented automatic enrollment, auto-escalate and simplified investment features over the past decade to enhance their plans, offering a retirement income menu to help employees generate retirement income is a natural next step.”
Features that plan sponsors should consider when developing and implementing a retirement income menu for plan participants, according to the issue brief, include:
• What type and how many retirement income methods should plan sponsors offer to employees?
• How should plan sponsors communicate the retirement income menu so that participants can make informed decisions about which retirement income method to choose?
• Should retirement income choices be offered “inside” the plan (e.g., managed payouts administered by the plan administrator or annuities delivered by an insurance policy held in the plan’s trust) or “outside” the plan (e.g., rollovers into individual annuity contracts).
• What fiduciary considerations should employers be concerned with when offering a retirement income menu?
Income-Replacement Goals Overlooked by Plan Sponsors, SHRM Online Benefits Discipline, January 2011
Americans Wish They Had a Pension, Would Consider Annuities, SHRM Online Benefits Discipline, August 2010
Reconsidering Annuities in Retirement Plans, SHRM Online Benefits Discipline, June 2010
401(k) Distributions: Easing Into Annuities, SHRM Online Benefits, June 2008
SHRM Online Benefits Discipline
SHRM Online Retirement Plans Resource Page