Turning allocations toward income: How default options can boost retirement savings

Trader Talk

Most plan structures today still don’t accurately reflect the urgent need to empower participants to efficiently secure income. Successfully entrenching income options in employer-sponsored retirement plans will also call for redirecting some robust participant allocations currently not geared toward income at all.

There are few doubts that guaranteed income is the future. But, what’s required to ensure a smooth transition is for more sponsors to move energetically to better align key plan design features, the default in particular, with income objectives — and actively combat inertia and point participants toward their income opportunity.

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Encouragingly, regulators are fully in step with the need for retirement plans to deliver income solutions: the passage of the SECURE Act now offers a clear regulatory path for including guaranteed life income annuities within employer-sponsored plans.

Sponsors strongly embrace secure income as a plan goal. Sponsors are about three times more likely to say their plan’s main purpose is providing secure income throughout retirement, as opposed to just considering them vehicles for accumulation, according to TIAA’s recent Retirement Insights Survey of 500 plan sponsors and 1,000 participants.

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But at the same time, 48% of sponsors say they aren’t offering in-plan GLI annuities, although nine of 10 of these sponsors are at least somewhat interested in doing so going forward.

Sponsors still on the fence regarding an in-plan GLI option can be assured that participant interest likely won’t be a hurdle. In recent years, our research has found consistent interest among plan participants in securing guaranteed income through their plan; such options, in fact, historically have been heavily utilized by 403(b) plan participants.

In our most recent survey, about 70% of all participants said they would consider a program that offered ways of obtaining guaranteed income to be very or extremely valuable. Fifty-one percent said they would be very or extremely interested in an in-plan GLI annuity specifically.

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Sponsors can draw additional motivation from this finding. Though half of participants are highly confident about their progress towards long-term financial goals, having a source of lifetime income gives such confidence a considerable boost, to 80% of participants.

Participant sentiment might not be an obstacle, but sponsors adopting an income option will likely need to educate participants to adjust some long-established behavior regarding the allocation of their contributions.

Dollars going to non-income solutions

Target date funds have been attracting a greater share of participant dollars since 2006, when the Pension Protection Act enabled target date funds to become the qualified default investment option. In fact, most participants make no investment allocation decision at all and simply stick with their employers’ default investment option.

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From 2012 to 2018, the average DC plan participant increased the share of each of their contribution dollars that went to a lifecycle fund to 47% from 27%, while decreasing their allocation to every other kind of asset, according to TIAA Institute data.

Other research suggests that participants investing in the lifecycle asset class tend to use it as a single comprehensive fund-of-funds investment, averaging over 90 cents per dollar contributed each year.

As valuable as lifecycle funds are at accumulating assets, they have not directly addressed the income- generation need. Now, a new generation of target date fund (TDF)-like products is poised to change that — and merits taking some of the flow that traditional TDFs have effectively captured to date.

The case for better aligning default options with income needs is undeniable. But how can we best implement these choices?

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Leverage the power of the default option with new income-focused features:
It’s long been clear that plan “auto” features such as default investment options help drive optimal participation and outcomes.  Now, sponsors have a growing opportunity to adapt the default to income objectives.  New TDF-like products are available that incorporate an increasingly conservative asset allocation over time but also an embedded annuity or lifetime income option that replaces part of the fixed income portion for participants older than age 40. Such products facilitate a greater allocation of contributions to income by packaging the annuity within a plan option already very familiar to participants.

Gradually shifting allocations toward annuities during savings years lets retirement savers dedicate age-appropriate levels of their savings to income, while also ensuring that a sensible proportion of the portfolio remains ready to assume more risk and capture ongoing upside returns.

Importantly, leveraging a low-cost in-plan annuity also enables a saver to create a more effective mix of retirement income sources, including Social Security payments, systematic withdrawal, and variable and fixed annuity payments. By effectively mitigating the risk of any one income source, a diversified strategy better positions the saver to generate a diversified income stream that will create a guaranteed income floor that lasts a lifetime, maximized variable income to fund discretionary and fun expenses, access to money for emergencies and healthcare, and, finally, legacy goals.

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Some of these new products utilize customizable allocation models that the sponsor or a consultant can readily tailor according to specific workforce demographics and objectives, for example, modulating the annuitization to appropriately complement a pre-existing traditional pension benefit.

Encourage participants to think of income as an active, not simply an allocation decision: Sponsors also can subtly encourage participants who do their own allocation, instead of relying on the default, to closely consider dedicating at least some dollars to the income-oriented option. For example, one SECURE Act provision requires that plan sponsors now provide lifetime income calculations on participant statements. By simply raising awareness of income realities, sponsors can build awareness of income’s role and plan options that can help secure it.

Be sure to stress the “pension-like” value of the new, income-focused option:  Sponsors that adopt an embedded lifetime income default should definitely provide support and guidance on the reasons for the change – to help participants appreciate that, to the extent they use the option, they are literally building their own, personal retirement pension, a benefit that isn’t readily accessible to them otherwise.

Few DC plan features will signal greater value than the delivery of secure income – and building income generation into the plan default is rapidly emerging as a best practice for doing so. With income-focused defaults, sponsors can make a huge difference in the retirement confidence of their people.

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