Employers Cautious on ‘Lifetime Income’ Options in 401(k) Plans

Use of guaranteed income solutions among plan participants is low, as is their knowledge about them

By Stephen Miller, CEBS Aug 1, 2016
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Employers that sponsor 401(k) or similar defined contribution retirement plans remain slow to add lifetime-income annuities as an investment option within their plans, a new survey shows.

But they're warming up to other ways of helping retirees maintain guaranteed income throughout their retirement years.

What the financial industry calls "lifetime income solutions" include annuity products that provide a guaranteed income stream in exchange for retirement assets. A small but slowly growing number of mostly large employers offer the option of investing in an income annuity within their retirement plans, while others help employees shift all or some of their plan assets into an annuity outside the plan when they retire.

Providers of annuity products—investment firms and insurance companies, primarily—have been making their pitch to include annuities within defined contribution plans for years, and the Obama administration has lent some support to this approach. For example, in 2014 the U.S. Department of the Treasury and the IRS issued a final rule on purchasing longevity annuities within defined contribution retirement plan accounts.

A longevity annuity is a type of deferred income annuity that typically begins beyond age 70½—the age at which required minimum distributions (RMDs) from traditional IRAs and 401(k) plans of retirees must generally begin, continuing throughout the retiree's life.

But the Lifetime Income Solutions Survey report, published in July by consultancy Willis Towers Watson, found the majority of employers currently prefer lifetime income education and planning tools, and helping plan participants to make partial or systematic withdrawals during retirement, over more comprehensive approaches such as annuities or other insurance-backed products and managed payout options.

The survey was conducted in March and April, and completed by HR, benefit and finance executives at 196 large and midsize U.S. companies.

"Employees and retirees face major obstacles as they try to save for retirement so that they have a regular, adequate income that secures their future," said Bill Dewalt, senior investment consultant at Willis Towers Watson. "This is particularly true at a time when employers are increasingly concerned about financial well-being and retirement readiness. Life spans have lengthened, and competing financial responsibilities make it hard to save for retirement. Lifetime income solutions allow plan sponsors to continue their mission of preparing employees for life in retirement."

The most prevalent lifetime income solutions, the survey found, include offering:

  • Systematic withdrawals during retirement (provided by 73 percent of respondents).
  • Income planning tools (64 percent).
  • Education on ways to ensure lifetime income from retirement assets (60 percent).

Less common were more comprehensive approaches, such as offering:

  • Out-of-plan annuities (immediate, deferred, longevity or others), offered at the time of retirement, where the participant selects the provider using a third-party service or tools (19 percent).
  • In-plan deferred annuities as an investment option during working years (8 percent).
  • The ability for participants to roll defined contribution assets into a defined benefit pension plan at retirement (7 percent).
  • Out-of-plan annuities, available at the time of retirement, where the plan sponsor selects the providers (6 percent).

With regard to taking the leap into annuities, "the more effective solutions that help plan participants develop a steady flow of income in retirement are much less common, even though 71 percent of respondents said the primary reason for adopting a lifetime income solution was to help participants convert [defined contribution] plan balances into lifetime income," Dewalt said.

When asked why they had not adopted a lifetime income solution, 81 percent cited fiduciary risk as a very or extremely important barrier, while two-thirds cited cost. Six in 10 respondents said the market offerings and products were not satisfactory or were too new.

Participant use of lifetime income solutions also is low overall. At a majority of surveyed employers, for instance, respondents said that less than a quarter of plan participants made use, when available, of lifetime income education and planning tools. At roughly half of surveyed companies, fewer than 25 percent of participants used partial or systematic withdrawals during retirement.

Familiarity Increases Support

"Despite guidance issued by the IRS and Labor Department in 2014 clarifying that plan sponsors would not be responsible for the selection of annuity providers whose products are built into target date funds, sponsors have been slow to adopt in-plan annuity options," a July 21 post from BenefitsPro, a website for benefits brokers, managers and advisors, states.

Moreover, as of the end of 2015, about 35,500 defined contribution plans in the U.S. offered guaranteed lifetime income solutions, representing only 4 percent of plans, because many plan sponsors assumed there would be little interest from employees, according to a June 2016 report by Prudential Financial. 

Based on a 2015 survey of 1,000 employees, Prudential found 80 percent of plan participants intend to rely on their workplace plans as their primary source for retirement income.

"American workers need retirement solutions that have the potential to offer pension-like outcomes," said Sri Reddy, head of full-service investments at Prudential Retirement. These solutions "can help plan sponsors address many of participants' greatest unmet needs [by] securing an adequate source of retirement income."

Similar to the Willis Towers Watson findings, Prudential's survey found that, when compared with other retirement plan options, guaranteed lifetime income solutions are significantly less well known among plan participants—and far less used: Only about one-third of participants were familiar with them, and only 5 percent could confirm they use them.

But more than three-quarters of plan participants who said they were familiar with these solutions consider it important to include them in workplace retirement plans.

Participants who actually have experience with guaranteed lifetime income solutions tend to be more affluent, contribute more to their retirement plans and are generally more prepared for retirement, Prudential found. In other words, they are likely to be less in need of guaranteed income during their retirement years than their less-affluent colleagues who are less knowledgeable about these approaches.

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