Lifetime Income Solutions for DC Participants

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1 Lifetime Income Solutions for DC Participants Federal Regulators Offer New, Practical Guidance for Plan Sponsors 80% of participants responded that a guaranteed monthly payout benefit is a must have in their defined contribution plans. 2 The Departments of Treasury and Labor have issued new guidance for including lifetime income solutions in qualified retirement plans. 1 This guidance signals an important milestone in the evolution of defined contribution plans. By including lifetime income solutions in their investment menus, defined contribution plans have an opportunity to effectively provide a higher and more stable source of retirement income for participants. With new guidance in place governing certain lifetime income solutions, DC plan sponsors who want to enhance their plans to better serve their participants retirement income needs can begin to do so with greater clarity. Preliminary Guidance Sets the Stage for Plan Sponsors In a recent State Street Global Advisors (SSGA) survey, 80% of participants responded that a guaranteed monthly payout benefit is a must have in their defined contribution plans. 2 Yet many DC plan sponsors have been hesitant to adopt lifetime income solutions due to a lack of guidance from regulators regarding key issues. Recent guidance from regulators begins to answer some important questions that many plan sponsors have been asking about lifetime income solutions. For example: Where does an annuity-like option fit within a plan s Qualified Default Investment Alternative (QDIA) and how would it impact a plan s compliance with non-discrimination rules? What are the responsibilities of the plan sponsor when choosing an annuity provider? And what types of annuity-like features may be available to participants through a qualified plan? With new guidance in place from the Departments of Treasury and Labor, plan sponsors may begin to shift from conversation to action when it comes to offering lifetime income solutions in their DC plans. Guidance at a Glance At a high level, regulators have outlined the following guidance for plan sponsors: By including an allocation to unallocated deferred annuities within a series of target date funds, plan sponsors may add a unique feature for a sub-set of participants and would not be in violation of certain non-discrimination requirements. A series of target date funds that includes unallocated deferred annuity units could satisfy the requirements to be considered a QDIA as long as all other QDIA requirements continue to be met. Plan sponsors may outsource selection of the annuity provider to a third-party investment manager subject to the investment manager serving in the capacity of an ERISA 3(38) fiduciary and continuing to pursue a process of selection consistent with the annuity selection safe harbor. The plan sponsor would still be required to exercise its fiduciary responsibilities related to the hiring and monitoring of the investment manager.

2 How a Lifetime Income Solution May Work In today s marketplace, most Target Date Funds are designed to roll-down to an asset allocation that remains static throughout the remaining years of retirement (i.e., post-target date). The Target Date Fund structure identified in the guidance from the Department of Treasury allows each fund that includes unallocated deferred annuities as part of its fixed income fund to be made available only to participants whose retirement age is within a few years of the fund s target date. Upon reaching that target date, the fund itself will dissolve. Participants will be allocated their proportional share of annuity contracts for immediate (or deferred) payment (based upon the participant s election) and their proportional share of investment assets that must be invested into other plan options at the direction of the fiduciary or the participant, upon election. Participants who would not choose to have a portion of their assets auto-annuitized would have the option to transfer the relative balance out of the Target Date Fund and re-invest in other plan investment options. Based on this guidance and example from the Departments of Treasury and Labor, we can begin to envision a framework for what a lifetime income solution might look like for participants. This regulatory guidance governing the inclusion of annuitylike options in DC plans is new and has not yet been fully implemented in practice. The diagram below is designed to illustrate the basic concepts. Within the context of Target Date Funds, annuities may simply join the investment mix based on participants time horizons. Annuities could potentially help participants manage key risks, including longevity risk and liquidity risk. Insights and Analysis At SSGA, we draw upon deep experience in managing Target Date Funds and custom Target Date Funds for many of the world s largest plan sponsors. We have engaged with many of the largest plan sponsors who are considering lifetime income solutions to learn more about their product design preferences and to better understand how to meet the needs of their participants. We applaud the recent guidance from the Departments of Treasury and Labor, which is consistent with our existing philosophy for creating retirement income solutions for plan participants. Our research and conversations with clients experiences indicate a strong interest among both employers and employees in continuing to make defined contribution plans more robust vehicles for enhancing retirement readiness and improving post-retirement financial wellness. Conceptual Illustration of Retirement Income Product A strategy designed for lifetime income that is simple and transparent for participants ACCUMULATION DECUMULATION LIFELONG INCOME 55 65* 80** Phase 1 Phase 2 Phase 3 Phase 4 Annuity Purchases Annuity Holdings Annuity Payouts Phase Age Portfolio Characteristics 1 Prior to 55 Accumulates assets and operates like a normal target date strategy Purchases unallocated advanced lifedeferred annuities and incorporates into fund allocation Income distributed through the sale of investment assets, while maintaing the quantity of annuity contracts Income distributed in the form of annuity payments. Source: SSGA Defined Contribution. *Assumed age at retirement. **Assumes at age 80 portfolio balance is depleted. For illustrative purposes only. State Street Global Advisors 2

3 As employers move away from defined benefit plans, we believe it s important to convert participants savings within a defined contribution plan into a lifetime income stream as they approach retirement. When it comes to retirement security, participants decumulation and distribution strategies are just as important as their accumulation and savings strategies. Including lifetime income solutions in target date funds helps participants navigate a number of practical issues as they near retirement and make important decisions about how to convert their savings into income. Including lifetime income solutions in the context of target date funds offers participants the option to remain in their plan if they choose, rather than taking a lump-sum distribution or rolling their balances to higher-fee Individual Retirement Accounts (IRAs). When participants choose to stay in the plan, they have access to retirement income products that plan sponsors have evaluated and negotiated on their behalf, allowing participants to benefit from an institutional level of due diligence and potential cost savings versus retail annuity products. What Plan Sponsors Say 94% of plan sponsors are concerned about the post retirement phase for participants 86% of plan sponsors believe in providing participants with lifetime income solutions 73% of plan sponsors think participants are unaware of retirement income solutions within defined contribution plans What Participants Say 69% of participants believe they will need guaranteed income source in addition to Social Security 51% of participants would like retirement income to be made available through their defined contribution plan 80% of participants expressed that a guaranteed monthly payout benefit is a must-have Source: SSGA Biannual DC Investor Survey, July 2013, Please see page 5 for survey methodology. Impact on Non-discrimination Testing and Choice of QDIA By including annuity-like options within a family of target date funds, plan sponsors would not fail non-discrimination requirements through the addition of this feature. The Department of the Treasury provided guidance that allows a series of age restricted Target Date Funds to satisfy 401(k) plan non-discrimination requirements if the series of Funds incorporates unallocated deferred annuities as part of the overall asset allocation, presumably as a substitute for a portion of the broader Fixed Income asset class allocation and allows participants of all ages access to at least one of the Target Date Funds in the series. The basis for this ruling was the perception (or uncertainty) that providing a unique benefit to some employees (those who are older and typically more highly compensated) might violate the nondiscrimination rules applicable to defined contribution plans. In essence, a series of Target Date Funds is deemed to have satisfactorily met requirements for non-discrimination through the inclusion of unallocated deferred annuities even if one Fund within the series (but without the unique benefit) would have not met the non-discrimination requirements. Focus on Due Diligence Plan sponsors can outsource selection of the annuity provider to a third-party investment manager, but they are still responsible for overseeing the investment manager itself. This allows a Plan Sponsor to designate the selection of the insurance provider to an investment manager, as long as that investment manager serves in an ERISA 3(38) fiduciary capacity and follows the process inherent to the Annuity Selection Safe Harbor. The Plan Sponsor would still be required to exercise its fiduciary responsibilities related to the hiring and monitoring of the investment manager. Examining the Regulatory Guidelines in Greater Detail Here s a closer look at some of the guidelines from federal regulators governing lifetime income solutions. We welcome the chance to discuss these guidelines and their implications with you and your DC investment committee. State Street Global Advisors 3

4 Meeting ERISA Standards The Department of Labor guidance also provides that the selection of the unallocated deferred annuity contracts satisfies the requirements of section 404(a)(1)(B) of ERISA if the designated investment manager choosing the annuity provider satisfies each of the conditions of the annuity selection safe harbor. In association with the guidance from the Department of Treasury, the Department of Labor provided subsequent guidance in a letter to Treasury, providing that the series of Target Date Funds including unallocated deferred annuity units described in Treasury s notice could satisfy the requirements necessary such that the Funds could serve as a QDIA so long as all other QDIA requirements continued to be met. Including Guaranteed Benefits for Participants Regulators have, thus far, excluded guaranteed withdrawal benefits for participants, but guidance on this issue may continue to evolve. Presently, Guaranteed Minimum Withdrawal Benefits (GMWB), Guaranteed Lifetime Withdrawal Benefits (GLWB), and similarly structured variable annuity products do not fit the criteria that the Department of Treasury has set forth to achieve in the relief noted above. The Department of Treasury has, however, made it explicitly clear that it has not closed the door to those types of products, including variable annuities, from being considered. At this first stage of rulemaking and guidance, the Department of Treasury sought to focus its efforts on products believed to offer greater consumer protection in addition to longevity risk management, which included facets such as ease of comprehension, simplicity, low price and transparency. Variable annuity structures may still be included in the future, but this specific ruling/guidance is likely to encourage broader development of the market for longevity insurance. Exploratory Steps for Plan Sponsors Survey your participants to better understand how they experience your current plan and how steps to strengthen retirement security through lifetime income solutions might be met. If you have target date funds in your DC plan, ask SSGA for an analysis of your current glide path design and recommendations about how your glide path could be adjusted or updated to better meet participants retirement income needs. Review distribution options for participants entering retirement and consider what changes or enhancements could be made to contribute to participants post-retirement financial well-being. Engage with other plan sponsors at industry events and roundtables. Find out what questions other plan sponsors are asking and what feedback they are getting from their own participants about lifetime income solutions. SSGA will continue to facilitate dialogue among plan sponsors about lifetime income solutions at events we host and events we attend as a thought leader. From reviewing your choice of target date funds to evaluating whether custom target date funds might make sense for your plan, we can help you create a roadmap for better meeting the lifetime income needs of your participants. Making retirement work SSGA invites you to continue the retirement income discussion. We are committed to developing solutions that promote retirement readiness and strive to help break down the barriers that may be standing between participants and their goals for retirement income. Our team of Defined Contribution Strategists can work with you and your relationship manager to understand your particular needs and provide appropriate solutions. To learn more, contact your relationship manager or our team of investment strategitst at Together, we can make retirement work. Continuing the Dialogue, Moving it Forward While lifetime income solutions, including annuity-like products, are still in the early stages of development among retirement plan service providers, there are a number of steps plan sponsors can take today to begin taking advantage of recent guidance from federal regulators. SSGA can work with plan sponsors and their investment committee to take action on any of the following exploratory steps that may interest you. State Street Global Advisors 4

5 Survey Methodology The SSGA Biannual DC Investor Survey July 2013 was fielded in partnership with TRC Market Research, an independent marketing research firm located in suburban Philadelphia. To protect the anonymity of the respondents, TRC was responsible for survey administration and data analysis. SSGA received the aggregate data for analysis purposes only. The data were collected in April 2013 through a 20-minute Internet survey using a panel of 1,498 verified 401(k), 403(b), 457 and profit-sharing plan participants and retirees, age 40 to 70, who were actively engaged with their plans. The results were weighted to reported defined contribution plan types and retirement status. The sample has a maximum sampling error of +/-2.5 percentage points at a 95% confidence level SSGA Biannual DC Investor Survey July Please see above for survey methodology. Glossary of Terms Page 2 Target Date Fund An investment fund designed to adjust an asset allocation mix over time typically by becoming more conservative as the target date (usually retirement) approaches. Annuity A financial product offered by an insurance company and designed to accept and grow funds from an individual and then, upon annuitization, pay out a stream of payments to the individual over a specified period of time. Annuities are often used to secure steady cash flow during retirement years. Page 3 Longevity Risk The risk that an individual will live longer than expected with the potential result of exhausting all income sources before death. Liquidity Risk The risk stemming from the lack of marketability of an investment that cannot be bought or sold quickly enough to prevent or minimize a loss. Liquidity risk is typically reflected in unusually wide bid-ask spreads or large price movements (especially to the downside). Defined Benefit Plan An employer-sponsored retirement plan where employee benefits are derived from a specified formula using factors such as, but not limited to, salary history and duration of employment. Investment risk and portfolio management are entirely under the control of the company. Defined Contribution Plan An employer-sponsored retirement whereby employees make contributions to accumulate wealth during their working years to provide income in retirement. Often times, an employer will match an employee s contribution, up to a certain amount. IRA Individual Retirement Account, an investment account used by individuals to save for retirement. ERISA 3(38) The Employee Retirement Income Security Act (ERISA) is a Federal law that sets standards of protection for individuals in most voluntarily established, private-sector retirement plans. ERISA requires plans to provide participants with plan information, including important facts about plan features and funding; sets minimum standards for participation, vesting, benefit accrual, and funding; provides fiduciary responsibilities for those who manage and control plan assets; requires plans to establish a claims and appeals process for participants to get benefits from their plans; gives participants the right to sue for benefits and breaches of fiduciary duty; and if a defined benefit plan is terminated, guarantees payment of certain benefits through a Federally chartered corporation, the Pension Benefit Guaranty Corporation (PBGC). (Source: dol.gov) Section 3(38)(B) of Title I of ERISA was also amended to reflect the above-described changes to the investment adviser registration requirements under the Advisers Act.\5\ Specifically, section 3(38)(B) of ERISA requires that, to be an investment manager under Title I, an investment adviser must: (i) Be registered with the SEC under the Advisers Act of 1940, or (ii) if not registered under such Act by reason of paragraph (1) of section 203A(a) of such Act, be registered as an investment adviser under the laws of the state in which it maintains its principal office. State Street Global Advisors 5

6 ssga.com State Street Global Advisors One Lincoln Street, Boston, MA T: This material is for your private information. Investing involves risk including the risk of loss of principal. The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA s express written consent. The views expressed in this material are the views of the SSGA Defined Contribution team through the period ended 02/28/2015 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information State Street Corporation. All Rights Reserved. State Street Global Advisors ID3472-DC Exp. Date: 03/31/20166

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