Paving the way to a secure retirement: A model DC approach

Transcription

1 Paving the way to a secure retirement: A model DC approach

2 Life expectancy (age) % 73% % Probability at age 65 A couple at age 65 has an 89 percent chance of one of them living to 85; 73 percent to age 90; and 49 percent to age % American workers face a challenging path to a secure retirement. They are worried about having enough income to maintain their preretirement standard of living and running out of money in retirement. Considering that Americans reaching the age of 65 today may be expected to spend an average of 20 years in retirement, their concerns are well-founded and they need help from their employer-sponsored retirement plans to help them prepare for this possibility. That s why it is so important for retirement plans to focus on the right goal: helping employees not to accumulate a certain sum, but to generate a lifetime of income. Although the defined benefit (DB) plans that provided lifetime income for many workers have become scarcer, 2 effective defined contribution retirement plans need to retain their basic principle of providing an income stream for life. The defined contribution (DC) plans that have emerged as the primary retirement vehicle for the majority of American workers with employer-sponsored retirement plans have met this objective with mixed success. Separate DC plan types for different employee groups don t always share a common goal or structure. As it is more critical than ever for DC plans to help meet the lifetime income needs of workers, it is helpful to understand the ways in which plans serving the not-for-profit market have achieved success in this regard for decades. 2 Paving the way to a secure retirement

3 A model for defined contribution plans The purpose of a defined contribution retirement plan should be to help replace an adequate portion of a workers pre-retirement income typically between 70 percent and 90 percent, including Social Security and other savings throughout their retirement. A successful defined contribution plan should be built around lifetime income, and its structure, features and services should all contribute to that goal. This approach can provide workers with the certainty they seek for their retirement income. According to a 2014 survey, more than a third (34 percent) of respondents said the primary goals of their retirement savings plan should be to deliver guaranteed income every month to cover living costs. Another 40 percent wanted to ensure their savings would be safe regardless of what happens in the market. 3 Exhibit 1: Primary goal for retirement savings plan 40% Ensure that your savings will be safe regardless of what happens in the market Provide guaranteed money every month to cover your living costs in retirement Allow you to earn a competitive rate of return on your saviings Even with a prudent and well-thought-out systematic withdrawal strategy, retirees are at the mercy of market fluctuations and run the risk of running out of money. Source: TIAA-CREF 2014 Lifetime Income Survey *Note: Sample based on survey respondents participating in a retirement plan. Using systematic withdrawals to generate income in retirement, as some DC plans do, may not allow employees in many cases to meet either of those needs. Even with a prudent and well-thought-out systematic withdrawal strategy, retirees are at the mercy of market fluctuations and run the risk of running out of money. TIAA-CREF research shows that if retirees make withdrawals from their retirement savings that are equal to the income payments they would receive from a lifetime annuity (assuming the same interest rate), there is a greater than 50 percent chance that the retiree will outlive his or her savings. 4 Guaranteed products are therefore integral to helping workers create lifetime income. DC plans can make guaranteed products* available when an employee retires (an out-ofplan annuity) or embed them as a core menu option in their plan (an in-plan annuity). Both are valuable, but the use of an in-plan annuity increases the likelihood that employees will * Guaranteed income from annuities is subject to the issuing insurance company s claims-paying ability. Paving the way to a secure retirement 3

4 It is important to remember that current QDIAs are not structured to provide income guarantees at retirement and are not a retirement income solution on their own. use annuities to provide an income stream in retirement. A TIAA-CREF Institute study found that individuals who contribute to annuities while they are saving are more likely to annuitize their retirement savings and receive retirement income in the form of lifetime annuity payments. 5 The reason for this is behavioral: After a lifetime of saving that excludes annuities, employees are less likely to want to give up control of a large lump sum of their nest egg through annuitization. By contrast, in-plan annuity savings can help employees understand how fixed annuities work and their positive impact on future retirement income. Along with offering financial products that can provide guaranteed income, DC plans should also offer diversified investment options, including a Qualified Default Investment Alternative (QDIA) for workers automatically enrolled in the plan. However, it is important to remember that current QDIAs are not structured to provide income guarantees at retirement and are not a retirement income solution on their own. The good news is that a recent IRS notice and DOL information letter facilitates the use of deferred annuities within target date funds (TDFs) held in defined contribution plans. This could encourage the use of annuities within TDF QDIAs as a best practice across DC plans. With lifetime income as the objective, designing a plan with a purpose is critical to helping employees reach their goal. DC plan design elements should seek to maximize plan participation and encourage employees to save enough to generate sufficient income in retirement. The use of automatic features and employer match design strategies such as stretching the match or adding an employer match if one does not exist can play an important role in boosting participation and savings rates. Safeguarding plan assets for instance, by limiting loans should also play an important role in plan design to avoid the premature withdrawal of assets. Ultimately, plan design should help put employees in the best position to attain their retirement objectives. 4 Paving the way to a secure retirement

5 But plan design is only one key element of a more comprehensive offering. In order for a defined contribution plan to succeed, it must also foster a holistic approach to retirement planning that includes offering the education, advice and tools that employees need to reach their retirement income goals. This includes an effective employee engagement strategy that empowers employees to take an active role in their retirement planning decisions. Of the existing DC plan types, those serving the not-for-profit market are most closely aligned with this model DC plan. Lifetime income is central to retirement planning in the not-for-profit market As we noted earlier, there are different DC retirement plan structures, but not all of these types of plans have lifetime income as their objective. For example, 401(k) plans were originally introduced as a supplement to DB plans to encourage personal retirement savings. As DB plan coverage declined, 401(k) plans took their place as the primary retirement savings vehicle for many workers. However, 401(k) plans did not evolve to fill the guaranteed income void left by DB plans, and they maintained their original goal of accumulating retirement savings. This remains a key distinction between corporate 401(k) and 403(b) plans (see Distinguishing between 401(k) and 403(b) plans ). For other DC plans, such as those traditionally found in the not-for-profit market, providing employees with lifetime income was the original reason why they were created. Retirement plans serving the not-for-profit market are built around providing retirement income options through in-plan annuities for their workers, whether it s for 10, 20 or more than 30 years. This is especially important to the more than 26,000 TIAA-CREF retired clients over the age of 90 who are receiving annuity payments, and even more so for the 500-plus individuals over the age of 100 who are also receiving annuity payments. 6 Retirement plans serving the not-for-profit market are built around providing retirement income options through in-plan annuities for their workers, whether it s for 10, 20 or more than 30 years. Guaranteed income options especially in-plan fixed annuities are what allow not-for-profit plans to provide their employees with retirement income options that will last a lifetime. Not only do fixed in-plan annuities provide a guaranteed benefit that never goes down; they also serve to manage risk in employees overall portfolios while they are saving, due to fixed annuities lack of volatility. Not-for-profit DC plans actively take a plan design with a purpose approach, with features that are intended to help employees save enough to generate adequate lifetime income. For instance, plan features encourage employees to save at an industry-recommended 10 percent to 15 percent of compensation, allocating those savings to age appropriate investment options, and minimizing costs. Many plans mandate employee contributions as a condition of employment a feature seldom used with for-profit plans and also offer employer matches. Such plans are especially effective in higher education: Combined employer and employee contribution rates at TIAA-CREF average 12.8 percent. 7 Paving the way to a secure retirement 5

6 As DC plans embrace change, it is critical for them to maintain their focus on the end goal of lifetime income. Plans should continue to make changes that support this goal and ensure that effective plan features such as annuity options are not removed from plans. Distinguishing between 401(k) and 403(b) plans Changing regulations and broader industry agreement on best practices are contributing to the increasing similarity of most DC retirement plans. These similarities across plan structures are benefiting both plan sponsors and employees by contributing to a greater consistency in retirement plan approaches. They are also helping to reduce plan administration and oversight costs as DC plans are increasingly adhering to the same set of regulations. Yet even as the differences between 403(b) and 401(k) plans decrease, there is still a critical gap between the two namely, in the inability of the existing corporate 401(k) model to generate income that employees cannot outlive. Below are some of the key differences that distinguish these plans. Availability Retirement plan goal 401(k) Typically offered by for-profit companies although there are some exceptions Originally designed to be a supplemental retirement plan primarily focused on wealth accumulation 403(b) Available to employers of tax-exempt 501(c)(3) organizations such as schools, hospitals, churches, charitable organizations and public educational institutions Originally designed to provide lifetime income through annuity contracts Investment menu Retirement income Typically comprised of investment options (e.g., mutual funds) that are not intended to generate retirement income Typically rely on systematic withdrawals and lump-sum distributions without offering guaranteed income products 8 within the plan. Some plans may offer out-of-plan annuities at the point of retirement Annuity products are commonly offered with plan investment options. Many plans also make in-plan annuities available to participants Guaranteed products are typically offered to provide income for life Employee engagement Historically have offered limited resources to support employee financial well-being past retirement, although they are increasingly adopting retirement engagement strategies similar to those of a 403(b) Commonly offer comprehensive engagement efforts aimed at getting workers both to and through retirement Both plan types are important to the retirement security of American workers and they can learn from each other. 403(b) plans have adopted many 401(k) operational and design practices, while corporate plans that maintain wealth accumulation as their primary goals can learn from the lifetime income approach of not-for-profit plans. However, as DC plans continue to embrace change, it is critical for them to maintain their focus on the end goal of lifetime income. Plans should continue to make changes that support this goal and ensure that effective plan features such as annuity options are not removed from plans. This is especially true as recent regulatory developments point to the Department of Labor placing greater importance on lifetime income as a key objective in retirement planning. 6 Paving the way to a secure retirement

7 In addition to embracing plan design with a purpose, not-for-profit retirement plans commonly offer communications, advice and guidance programs focused on getting employees to their retirement goals. This means offering different types and levels of engagement strategies that will allow employees to help meet their retirement income needs. It also means providing employees with participant income statements that translate retirement plan savings to expected income in retirement not accumulated wealth. Personalized engagement strategies are a central part of the offering too, especially advice services that help employees make both broad retirement planning decisions as well as individual fund selections. Defined contribution plans in the not-for-profit market were originally designed to provide lifetime income. In contrast to other types of DC plans, not-for-profits plan structures, product offerings, design and services commonly revolve around income replacement and creating a secure retirement for their employees. Matching the plan with the right goal Employer-sponsored retirement plans play an essential role in preparing workers to generate a lifetime of income, and people rely on their employers to help them reach a secure retirement: 81 percent of workers trust the financial information provided by their employer. 9 What matters most is that workers have access to a DC retirement plan structure that has the right goal. Retirement plans focused on wealth accumulation can move employees closer to a secure retirement but they can t address workers concerns about outliving their nest eggs. A lifetime-income approach provides employees with the opportunity to generate income for their essential needs that can last a lifetime and, when combined with other sources of retirement income, can help them reach their retirement goals. Not-for-profit plans have had lifetime income as their objective from their inception and can help employees to and through retirement with the knowledge that they have access to guaranteed income that they can t outlive. Paving the way to a secure retirement 7

8 1 TIAA Actuarial (based on 2014 TIAA dividend mortality) Pension Insurance Data Tables, Table S-31, PBGC. 3 TIAA-CREF s first Lifetime Income Survey was conducted by an independent research firm in January, Polling was among a national random sample of 1,017 adults, age 18 years and older. 4 TIAA-CREF Institute: TRENDS AND ISSUES (10/06). The payout annuity assumes a 65-year-old retiree, single-life annuity with 10 years guaranteed, 4 percent rate of return, and the mortality assumptions used in computing current total income under TIAA or CREF payout annuities. 5 Paul J. Yakoboski, Retirees, Annuitization and Defined Contribution Plans, Trends and Issues, TIAA-CREF Institute, April TIAA-CREF as of 12/31/14 7 TIAA-CREF calculates employee and employer contribution rates using participants where annual salary is known. We have determined that this subset of our participant base is a representative sample of our active contributing participant population. EE CONTR = Annual Employee Contributions/Annual Salary; ER CONTR = Annual Employer Contributions/Annual Salary. 8 All guarantees are subject to the claims-paying ability of the issuing company 9 The findings come from TIAA-CREF s first Investment Options Survey, conducted by an independent research firm between January 3 and 5, Polling was among a national random sample of 1,017 adults, age 18 years and older. The margin of error for the entire sample is plus or minus 3.1 percentage points. Annuities are designed for retirement and other long-term goals and offer payment options including lifetime income. Guarantees are based on the claims-paying ability of the issuer. Payments from variable annuities are not guaranteed and will rise or fall based on investment returns. Withdrawals of earnings from an annuity are subject to ordinary income tax plus a possible federal 10% penalty if you make a withdrawal before age 59½. Investment, insurance and annuity products are not FDIC insured, are not bank guaranteed, are not bank deposits, are not insured by any federal government agency, are not a condition to any banking service or activity and may lose value. TIAA-CREF products may be subject to market and other risk factors. See the applicable product literature, or visit tiaa-cref.org for details. You should consider the investment objectives, risks, charges and expenses carefully before investing. Please call for a current product and fund prospectuses that contain this and other information. Please read the prospectuses carefully before investing. TIAA-CREF Individual & Institutional Services, LLC, Teachers Personal Investors Services, Inc., and Nuveen Securities, LLC, Members FINRA and SIPC, distribute securities products. Annuity contracts and certificates are issued by Teachers Insurance and Annuity Association of America (TIAA) and College Retirement Equities Fund (CREF), New York, NY. Each is solely responsible for its own financial condition and contractual obligations Teachers Insurance and Annuity Association of America-College Retirement Equities Fund, New York, NY C _ A14718 (03/15)