What Plan Sponsors Should Know About Lifetime Income Solutions

The number of U.S. workers who are covered by a defined benefit pension plan dropped by nearly half between 1980 and 2008, from 38 to 20 percent, and continues to steadily decline. More employers have adopted a defined contribution plan, which shifts the responsibility of saving and making investment decisions to their employees. However, many participants underestimate how much they should have in retirement and can deplete their resources much sooner than planned. Thus, in the absence of a pension plan, the need for retirement lifetime income solutions is evident. What should plan sponsors know about adopting and implementing lifetime income solutions in their plan?

What Are Lifetime Income Solutions?

Unlike defined contribution plans, which require participants to make their own investment decisions and set their own asset allocations to achieve a certain level of retirement wealth, lifetime income solutions offer investors a set, steady stream of income during retirement. While lifetime income solutions don’t have all the same features of pensions, like pensions, they can supplement Social Security benefits to provide a minimum monthly income over the participant’s lifespan, where retirement savings may fall short.

Projecting how much money one will need in retirement can be a challenge, even for financial experts. Those who are too conservatively invested could be losing out on future gains, while those who are close to retirement and are invested too aggressively could be putting their financial security at risk. By adding lifetime income investments to the menu, plan sponsors can give participants a way to boost their future finances in a predictable manner.

These investments can include annuities, guaranteed income funds, and other assets that promise a minimum return in exchange for an initial lump sum investment (or a series of periodic investments).

Annuities

An annuity is an insurance product that essentially functions like a private pension. By buying an annuity for a fixed sum, the investor can elect to receive regular monthly or periodic payments—either immediately or at some future point. These payments can be subject to a guaranteed minimum (fixed income annuities) or to a periodic adjustment (variable income annuities).

For example, a 45-year-old investor who wants an additional $1,500 per month beginning at age 65 could purchase a fixed income annuity for $250,000. Assuming a six percent return rate and three percent inflation, this $250,000 would be sufficient to generate $1,500 per month in income for more than 28 years.

Because the fixed annuity-generated income is guaranteed, the investor is protected against any market fluctuations that could otherwise jeopardize their nest egg. And for variable income annuities, the principal can increase if the fund performance exceeds expectations.

Guaranteed Income Funds

Plan participants who don’t want to purchase an annuity themselves can instead opt to invest in a guaranteed income fund. Like mutual funds and exchange-traded funds (ETFs), these fixed-income funds allow participants to purchase shares of funds that offer a guaranteed yield during their investment phase. Many of these funds also offer dividends, which can be withdrawn for extra income or reinvested for growth.  They may also offer a fixed payment stream typically beginning at retirement, although many are only investment vehicles.

Plan Sponsor Options and Obligations

Plan sponsors who are considering adding lifetime income solutions as part of their retirement plan offerings should consider a couple of decision points.

In-Plan or Out-of-Plan Assets

Sponsors can keep plan assets in the plan even after an employee’s retirement, which provides them with more control and oversight over risk, return, and withdrawals—but also requires them to maintain tight control and exercise fiduciary duties. Although keeping assets in the plan can reduce administrative fees, it can also increase the plan sponsor’s liability risk due to the necessary fiduciary and administrative oversight functions.

On the other hand, plan sponsors who require employees to withdraw all assets at retirement avoid a great deal of liability exposure. This may come at the risk of frustrating plan participants who might not want to go through an asset transfer. By investing in resources that can assist with this transition, plan sponsors can better meet their participants’ needs and objectives.

Managed Plans or Self-Managed Plans

In-plan and out-of-plan solutions can be professionally managed or self-managed. Managed programs use professional investment advisors to tailor an investment and withdrawal plan based on the participant’s unique goals. Self-managed programs allow participants to select their own asset allocations, withdrawal dates, and amounts.

Both the hands-on and hands-off approaches have benefits and drawbacks. Professionally-managed plans can have higher fees than self-managed plans, but may also generate higher returns. Self-managed plans are riskier, but provide the participant with more control.

Plan sponsors who run self-managed programs should ensure that they make appropriate educational documents available to all participants. By providing some basic materials on asset allocation, investment selection, and risk tolerance, sponsors can give employees the tools they need to make informed investment decisions over providing income over their lifetime.

Get Professional Assistance

It will take thorough evaluation on whether this option will be beneficial to your plan and plan participants. Consider getting unbiased help from a professional consultant that is not tied to an investment fund or recordkeeper. PlanPILOT is an independent registered investment advisor, not tied to any funds or investment banks. We help clients control their risks in operating retirement plans and help them deliver the benefits intended. For more information on lifetime income solutions or how we can help your retirement plan administration team, contact us at (312) 973-4911.

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