Retirement Moderator: Peter Gallagher National Sales Manager, Institutional Business Development, Invesco Jon Vogler Senior Analyst, Retirement Research, Invesco Roundtable The benefits and challenges of offering retirement income strategies in your DC plan Marcia Peters, CFA Chief Investment Officer, Portfolio Evaluations, Inc. Frederick Stewart Managing Director, Portfolio Evaluations, Inc. Richard Hiller Senior Vice President, Government Markets, TIAA-CREF Brought to you by: In the media and at pension industry conferences, retirement income solutions has been one of the most talked-about topics among plan sponsors and industry professionals. With the defined benefit (DB) plan no longer taking center stage as a primary source of retirement income, the focus is on defined contribution (DC) plans to help balance the proverbial three-legged stool. We ve assembled an outstanding panel of industry experts to share their insights and perspectives on what s going on in the retirement industry to address the retirement income needs of plan participants. Peter: Jon, both DC plan sponsors and service providers have been discussing the creation of DB-like retirement income solutions for plan participants for some time, but we haven t seen much adoption of these strategies. Can you help put the retirement income discussion in perspective? Is it different this time? If so, what s different from previous attempts to find a strategy that works? Or is it just a continuation of a long process? Jon: The conversation about retirement income solutions in DC plans started to intensify a few years ago when the baby boomers began to retire. The combination of the aging of the US population, rising life expectancies and the increasing use of DC instead of DB plans which typically provide for an annuity payout at retirement moved the emphasis from an exclusive focus on accumulating retirement assets toward a discussion on how to make retirement income last for a lifetime. Two years after the Department of Labor (DOL) and the Treasury Department issued a highprofile Request for Information regarding how DC plans could better provide lifetime income, the IRS and the Treasury Department in February released an initial package of guidance intended to remove regulatory barriers and simplify offering lifetime income benefits to retirees. This guidance included a proposed regulation that would allow retirees to address the risk of outliving their assets by using a limited portion of their savings to purchase guaranteed income for life that doesn t begin paying out until the owner is at an advanced age such as 80 or 85 (a longevity annuity). The package also included guidance that would provide a road map for offering employees the option of transferring some or all of their 401(k) plan payouts to their employers DB plans in exchange for an immediate annuity (Revenue Ruling 2012-4).
Bills Impacting Lifetime Income Options in Retirement Plans Bill Description Outlook Retirement Plan Simplification and Enhancement Act of 2012 HR 4050 Neal (D-MA) Lifetime Income Disclosure Act S 267 Bingaman (D-NM) Would, among other items, (a) clarify the administration of joint and survivor annuity rules, (b) increase the portability of in-plan lifetime income options, (c) clarify the law with respect to the availability of distribution options and (d) provide an exception from the required minimum distribution (RMD) rules when a retiree s savings do not exceed certain limits. Requires plan sponsors of defined contribution plans to inform plan participants, on an annual basis, of the projected monthly income they could anticipate receiving if they took distributions as annuities (based on the amount of money in their accounts). The bill directs the DOL to issue factors that employers may use in calculating an annuity equivalent, as well as a model disclosure. Introduced 2/16/12 referred to Ways and Means Committee and Education and Workforce Committee. Introduced 2/3/11 referred to Health, Education, Labor and Pension Committee. The bill has widespread support. It may be adopted as a rider to other legislation. The basic provisions are also included under HR 1534. Similar bill (HR 677) introduced in House on 2/11/11 by Rep. Holt (D-NJ). The guidance also clarified that employers can offer their employees the option to use 401(k) savings to purchase deferred annuities and still satisfy spousal protection rules with minimal administrative burdens (Revenue Ruling 2012-3). It may be a long while before plan sponsors and employees can make these features a regular part of their retirement plans. Much of the guidance is in proposed form and not yet final; furthermore, there are no clear rules at this point about the fiduciary implications of offering deferred annuities as investment options in DC plans. The new guidance, though, does represent an important step forward in advancing the discussion about lifetime income options in DC plans. Additional guidelines are expected later this year from the DOL and Treasury, including a new DOL requirement for plan sponsors to communicate to participants in DC plans the lifetime income that may be provided by their account balance. Peter: As one of Invesco s legislative experts, what type of congressional support are you seeing in the area of retirement income options within DC plans? What are some of the concerns expressed among regulators? Jon: The Lifetime Income Disclosure Act (S 267) was introduced in Congress in February 2011 by Sen. Bingaman (D-NM). Similar to the expected DOL guidance, this bill would require DC plan sponsors to inform participants, on an annual basis, of the projected monthly income they could anticipate receiving if they took distributions as annuities based on the amount of money in their accounts. The bill has widespread support, although it may be more likely to be adopted as a rider to other legislation, unless Congress decides to defer to the DOL on this issue. Among other items, the Retirement Plan Simplification and Enhancement Act of 2012 (HR 4050), introduced by Rep. Neal (D-MA) in February 2012 would increase the portability of in-plan lifetime income options. From a public policy perspective, there is concern that retirees maximize their retirement income to meet their monthly expenses for quality-of-life reasons, as well as to limit their dependence on government safety net programs. With respect to lifetime income products, regulators are concerned about addressing both plan sponsor concerns including potential liability for providing information to participants about these options, the selection and solvency of providers and the portability of the options and participant concerns such as costs, control and the seeming complexity of the products. Education is also a key concern. Employees have received instruction on how to save, but they haven t received much in the way of guidance on how to draw down their savings to make them last a lifetime. While there are regulatory guidelines for providing participant education without its being considered investment advice when it comes to using accumulation products in a retirement plan, those guidelines in the DOL s Interpretive Bulletin 96-1 haven t been updated to address products related to the distribution of assets so-called decumulation products. Peter: Marcia and Fred, from your perspective as investment consultants, what do you think are the key drivers for the demand in retirement income products? Do you think sponsors really want to provide these benefits, or do you feel that their hand is being forced? Marcia: From our perspective, there are two key issues that we feel are driving plan sponsors to consider retirement income solutions. The first is the concern that participants aren t going to have enough income beyond their retirement age. The second issue comes from conversations we ve had with clients. It s that morale boost employees feel when they have that sense of retirement readiness. Plan sponsors have acknowledged that over the last 10 years there has been a shift from the traditional DB plans to DC plans. Add the increase in life expectancy, and the combination of these two issues has left many plan participants without that security of guaranteed income throughout all of their post-retirement years.
To illustrate this concern, in March 2012 the Employee Benefits Research Institute (EBRI) conducted an annual retirement confidence survey that showed 23% of all employees lack complete confidence in their ability to have sufficient income to live comfortably during their retirement. The events over the last three to four years have also created a lot of additional concern for participants. I find these issues very disconcerting, especially as more baby boomers are retiring. Worker Confidence in Having Enough Money to Live Comfortably Throughout Their Retirement Years 40% 35% 30% 25% 20% We re hearing this directly from employers we work with and also seeing at industry conferences. Vendors have been working feverishly to try to get products out in the marketplace to fill this need. In fact, there are some stunning statistics that we came across for example, about 80% of the products out there are less than a year old. Vendors have been working feverishly to try to get products out in the marketplace to fill this need. In fact, there are some stunning statistics that we came across for example, about 80% of the products out there are less than a year old. Fred Stewart 15% 10% 5% 0% Very Somewhat Not Too Not At All So with most of the retirement income products just coming on market, we re seeing a delay in adopting these strategies despite the baby steps that the Treasury has proposed with offering these within a plan. I think a lot of plan sponsors don t understand what the marketplace looks like, although they do know that it s something that they will have to address. 2012 2011 Source: Employee Benefit Research Institute and Mathew Greenwald & Associates, Inc. 2011-2012 Retirement Confidence Surveys. To answer the second part of your question, I don t believe their hands are being forced because I do believe plan sponsors genuinely want to create an opportunity for their employees. An employee with an uncertain future is not a satisfied and productive employee. We ve seen several similar studies showing that a large percentage of participants lack the knowledge or ability to adequately prepare for retirement. So any solution that is good for participants is good business for employers. I think it s a combination of those things that are really driving plan sponsors to now start looking very seriously at this. An employee with an uncertain future is not a satisfied and productive employee. Marcia Peters Fred: Our plan sponsor clients are really struggling with this. They see it as a need and feel it s their responsibility, to a degree, to make sure that the employees are prepared. A recent Plan Sponsor Council of America (PSCA) survey states that only 16% of plans offered an annuity solution. The annuity option is a case of what s old is new again. Not too long ago, we had Qualified Joint and Survivor Annuity (QJSA) options within plans, and over the years plan sponsors and providers have worked very hard to eliminate (or at least provide alternate options) to the QJSA provisions. We re in a similar situation now where we re looking to provide this income stream on the back end. We re seeing the lion s share of employees still electing a lump sum at termination of employment. At the end of the day, I think that employees have become used to their employers developing a strategy for the DC plan to help oversee the investments. And I think they ll be looking to their employer to provide income solutions as well. Marcia: Jon mentioned the Treasury proposals that came out in early February, which are intended to encourage the use of full and partial lifetime annuity options in DB and DC plans. We ve also seen a landslide of information from ERISA law firms trying to interpret what these regulations mean. In large part, that may be why employers are not embracing income solutions yet because they have been waiting for some type of guidance and trying to see how this all shakes out. It will help answer some questions that plan sponsors have about these types of products, where they fit and the role of the fiduciary in all of this. A lot of things are starting to come together. The time is right to really start thinking about this. These are just proposed regulations, and we ll see more discussions over the next few months.
Retirement Distribution Options Offered in Profit Sharing and 401(k) Plans 120% 100% 80% 60% 40% 20% 0% 2009 2010 Lump Sum Installments Annuities Retain in Plan Source: Plan Sponsor Council of America (PSCA) 53rd and 54th Annual Survey, based on 2009 and 2010 data Peter: As you listen to your clients, what kind of retirement income strategies are they really looking for? Fred: What we ve seen to date is very low adoption from plan sponsors using these alternatives. Generally, the alternatives that we ve seen with clients in the industry are the products where they ll offer distribution alternatives in the plan. I think part of the reason, as we mentioned earlier, is that most of the income solution products now in the marketplace are still fairly new. And plan sponsors are really looking for some additional guidance from their ERISA Council and consultants to find out what s available in the marketplace. The fiduciary process is already in place for the plan sponsors to go through this. They ve been doing the right thing by looking at the investments for many years. And I think the process is more important than the actual product they select. In-plan and out-of-plan options include fixed annuities, guaranteed minimum income or withdrawal products or rollover options. Each client situation is different and unique. And a combination of employee demographics, cost and features, risks and administrative services factors into the ultimate choice. Fred Stewart Plan sponsor inertia is due primarily to the overwhelming product options being rolled out. You have the traditional insurance products that offer annuity alternatives. There are also mutual fund companies and other vendors offering managed account solutions. In-plan and out-of-plan options include fixed annuities, guaranteed minimum income or withdrawal products or rollover options. Each client situation is different and unique. And a combination of employee demographics, cost and features, risks and administrative services factors into the ultimate choice. Again, process in the selection is key. Marcia: Some of the products are complex, but they are no more complex than any other investment products when you get right down to it. It s not unlike the process a plan sponsor goes through when evaluating investment criteria for an investment offering; it s just a different set of criteria. Plan sponsors understand that the criteria are complex, but the evaluation process is manageable. Fred: We ve looked not only at the alternatives that are currently in the market, primarily annuity based options, but at possible future designs and alternatives as well. For example, we re starting to see clients look at the nextgeneration QDIAs, which would target replacement income instead of asset allocation. It s something that you could customize to your employee demographics. This may help mitigate the risks of maintaining that desired replacement rate, which includes inflation and longevity risk. Peter: Guaranteed lifetime income through a fixed annuity seems to be the most talked about solution, but do plan sponsors have any concerns about this option? If so, what are their primary concerns, and what are the things they should be considering? Marcia: This is an important question because this solution in particular has a guaranteed payment. A deferred guaranteed payment may be a concern because as we know, the guarantee is only as good as the company providing the guarantee. I think, in part, that s why these products are a little slow to get off the ground because clients are concerned about the credit risk of an insurance company, especially in light of the credit issues since 2008. To the extent these products are evolving to be more separate in other words, tied to the separate accounts of the insurance companies as opposed to the general accounts I think these products are starting to get more attention. Efforts to at least segregate the credit exposure of the plan sponsor from the general account of an insurance company are positive for these types of products. In addition to credit risk, fees are another big consideration. Many sponsors question whether the cost justifies the benefit. Two or three years ago, plan sponsors would say they re just expensive and didn t understand enough about the fees, so it was difficult for these products to get off the starting block, so to speak.
But now, given some of these other factors, plan sponsors are willing to take a look at the cost and understand the fees. Also, the providers are doing more to create more transparency about the fees and cost structure. To plan sponsors, these products can look like a black box. I think plan sponsors are a little afraid because they say that they don t understand it, don t really see the value in it and don t know what the risks are. And so the product becomes easier to dismiss. As consultants, we can go through the evaluation process with them and break that black box apart. If we start helping them understand not only the structure of the product, but the cost, the kind of liquidity clients would expect, the market risk, the credit risk and the administrative issues, supporting issues and recordkeeper type issues, then the comfort level goes way up. And once the comfort level goes up for this type of product, you ll see plan sponsors much more receptive to including it in their plan. Clearly, the events of the last few of years have brought to the forefront the whole concept of retirement readiness. If good income sources aren t there, participants still may retire, but they re going to be living on a much lower income and are not going to live at the same standard they had expected. That seems to drive plan sponsors to be more receptive to wanting to understand more about retirement income products. And as I mentioned, once you peel away the layers, it s like any other investment product. There are elements that can become very transparent and very understandable. Peter: As you conduct provider searches for your clients, do you see retirement income products beginning to play a key role in your provider search? Marcia: Yes. It s just like if you go back a few years with the same evolution of target date funds and managed accounts. As more guidance became available, consultants like us started discussing these types of products and expanded the type of search. Participants widen the net, so to speak. A number of years ago, there was more of a focus on who had the best core investment lineup in the plan. And now there are a lot of different factors, diverse product offerings and providers those types of services. Fred: I agree. It s no longer just a check-the-box exercise. Plan sponsors are more actively engaged than we ve seen them in more recent past. As an example, we recently completed an RFP for a large client. They were just as interested in the participant education, the communications campaign and the advice/ financial planning aspects and tools as they were about the costs and plan administration. The primary challenges plan sponsors face today are providing participants protection against inflation and income that s going to last a lifetime. Peter: Richard, as a defined contribution record-keeper, what type of approach are you seeing with government plan sponsor clients who want to offer income strategies for their participants? Do you see these strategies primarily being adopted by larger plan sponsors? If so, do you foresee these strategies eventually being adopted by smaller plans? Richard: Since TIAA-CREF was founded over 90 years ago, the purpose as an organization was to maintain financial security for non-profit and public sector employees to and through retirement. Asset accumulation is a secondary goal, or it s a goal along the way of getting to income replacement. For retirement income, the public sector relies primarily on the traditional defined benefit pension plan. But like the corporate sector, state and local governments continue to struggle with underfunded plans, and their approach to funding the retirement of their employees is evolving. Some of them are tackling the financial challenges by raising the retirement age, reducing benefits for new hires or increasing employee contributions. Many are considering alternative retirement plan designs. On the 457 side of the market, asset or wealth accumulation is more of the focus. There s not much talk about income options within those plans. The primary focus is on best in class mutual fund line ups with stable value, life cycle and target date investment options. With core retirement systems under increasing pressure, however, there may be a growing interest in income options from supplemental plans. The government markets are interesting. There s not a lot of small, standalone, defined benefit plans anymore. At one time, many small cities and counties had their own plan, but a lot of those small plans over the years have been consolidated into larger, state-run plans, while still maintaining their own 457 plan. Most large counties or cities still have their own defined benefit plans. It s at these larger levels like states, large cities or counties that are looking at defined contribution inclusion in their core plan by moving from those large DB systems to hybrid-like DB/DC arrangements. These hybrid DB/DC structures enable governments to maintain a reduced DB benefit for employees alongside a DC plan. The addition of the DC plan helps governments fulfill their financial obligations to employees while eliminating future unfunded liabilities. Peter: Marcia discussed how the addition of an income strategy to a retirement plan can be an important benefit to employees contributing to the overall productivity, quality and satisfaction. This is another driver for adopting this type of plan design. Are you hearing similar things from government plan sponsors? Richard: As we ve discussed, a lot of corporations have gotten rid of their defined benefit plans, so now their 401(k) plans have become their primary retirement vehicles, and those plans were designed to supplement something else. Now they are forced into the role of being the primary retirement vehicle. Since 401(k) plans were not equipped to be a primary retirement vehicle, there has been an awful lot of people approaching retirement that were woefully under prepared. Though we re starting to see a change in the design of these plans to recognize that they re serving a different purpose than what they were first implemented to do. The government market is somewhat different. Their supplemental plans are not becoming their primary plans. Their primary DB plans are remaining with a focus on income replacement, as they should be, while the 457 plan supplements whatever that core plan design is.
Peter: Portability and inflationary risk seem to be large concerns plan sponsors have when considering retirement income solutions. How does your firm address these concerns with your plan sponsor clients? Are there also concerns about participant adoption of these strategies? Richard: Portability was essentially the purpose behind the founding of TIAA-CREF. To give you a brief history, Andrew Carnegie was on the board of Cornell University and one of the things that he realized was that college professors basically never retire. They work until they die because they were encouraged to move several times during a career and they never accrued enough benefits in any one place to be able to afford a comfortable retirement. So they basically kept working and were encouraged to move several times during their careers in order to bring new ideas and teaching methods to different institutions. As a result, the Carnegie foundation created TIAA, which was effectively a defined contribution plan, although nobody really talked about it that way until much later. It was a plan designed to provide lifetime incomes to these professors. But to do it in a way that they were not penalized by moving from one employer to another during a teaching career. So portability really is the founding principle of the organization. A lot of plan sponsors got away from the focus of their plans being on retirement income and not offering annuities within the plan, especially deferred annuities during the accumulation phase. With the exception of general account type products which are a bit trickier there are not too many restrictions that would impact the ability to take those assets and move them into a plan at another employer. To address the second part of your question regarding inflationary risk the initial TIAA-CREF solution was to invent a traditional guaranteed annuity product. This was under the assumption that your retirement was going to stay relatively flat. We were founded in 1918 and this was a great vehicle up through World War II. After the war, we got into an inflationary economy and it became apparent that retirement income wasn t going to keep up with inflation. So we invented what became the world s first variable annuity, with the idea that the income coming out would be tied to equities. And in an inflationary environment, the value goes up and your income goes up. Since 401(k) plans were not equipped to be a primary retirement vehicle, there has been an awful lot of people approaching retirement that were woefully underprepared. Though we re starting to see a change in the design of these plans to recognize that they re serving a different purpose than what they were first implemented to do. Richard Hiller The last plan sponsor concern is whether or not employees will embrace income options. It s funny because when people were in DB plans and the only way that they were receiving income was from a lifetime annuity nobody really questioned it. But in a defined contribution construct, they do. Plan sponsors need to be concerned about the financial strength of who s providing that lifetime income - that s critical. Participants need to be aware of the charges and fees associated with that annuity or the vehicle driving that income. Peter: I d like to thank our distinguished panel for their insightful remarks. We hope this roundtable provides some additional perspectives on how the retirement industry is evolving to adapt to the growing need for retiree income. Note: Portfolio Evaluations, Inc. (porteval.com, 973 538 4347) and TIAA-CREF (tiaa-cref.org, 800 842 2252) are independent organizations and not affiliated with Invesco. Invesco Distributors, Inc. is a U.S. distributor for retail mutual funds, exchange-traded funds, institutional money market funds and unit investment trusts. It is a wholly owned, indirect subsidiary of Invesco Ltd. For more information on any of the topics discussed, please contact your Invesco representative. This roundtable is not intended to be legal or tax advice or to offer a comprehensive resource for tax-qualified retirement plans. Always consult your own legal or tax professional for information concerning your individual situation. All material presented is the opinion of the contributors and compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in an investment making decision. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Retirement income products or investments do not guarantee a profit or eliminate the risk of loss. Diversification does not guarantee a profit or eliminate the risk of loss. invesco.com/dc IDCIRR-BRO-4 4/12 Invesco Distributors, Inc. 5227