Benefits Products & Services

By Thomas A. McCoy, CLU

CONVERTING DEFINED CONTRIBUTION PLAN ACCOUNTS INTO LIFETIME INCOME

SECURE Act provision eliminates barrier for plan sponsors

Retirement plan sponsors generally have succeeded in motivating employees to save more in their defined contribution (DC) plans. The next logical step is to help workers convert their DC plan savings into an income that will last through their retirement. When workers are unsure about how to make the best use of their retirement funds, it is a problem for both employees and employers.

The pandemic has compounded any uncertainty that already existed. Older employees have less time to recover from market downturns than their younger colleagues. Workers on the brink of retirement 10 years ago faced the same problem when the financial crisis ravaged investment accounts. Now, another jolt.

“Market fluctuations make people think of their 401(k) plan differently,” says Roberta Rafaloff, vice president of institutional income annuities at MetLife. “They see that it’s not just a savings vehicle where they get this bag of cash at the end of the day. It’s meant to be an income replacement plan. They realize, ‘I need this money to live on. I need some guarantees in my portfolio.’

“During their working years, we believe employees should be focused on contributing as much as possible to their 401(k)s. Then when they get close to retirement, they need to plan how they will convert those funds into an income that will last the rest of their lives.”

Earlier this year, MetLife released research conducted by The Harris Poll which indicated that both employees and retirees recognize that they need help in turning their 401(k) balance into an income stream in retirement. Less than half (47%) of retirees and older workers said their employers gave them, or were giving them, appropriate resources and education to transition into retirement. An overwhelming number (95%) of workers and retirees said that a source of guaranteed income in retirement is important, including 63% who consider it “very important.”

The vast majority (88%) of employers in the study agreed that retirees need to have a source of guaranteed lifetime income. Among those that do not offer a guaranteed income product, 62% believe that older workers would be more likely to comfortably retire if they had a source of guaranteed retirement income from their workplace retirement savings. Yet only 17% of employers with a DC plan have an option for plan participants to convert some or all of their savings into a guaranteed income in retirement.

The primary obstacle that has held employers back is uncertainty over their potential liability if the annuity carrier they choose for participants were to run into problems in the future. Two-thirds of the employers said they had been waiting for the passage of legislation clarifying the safe harbor for annuity carrier selection before they would consider offering guaranteed lifetime options in their DC plans.

Most of those employers awaiting this safe harbor (82%) indicated they were likely to offer a guaranteed income option within five years of the clarification being issued. Last December, they received that clarification when the SECURE Act was signed into law. Among other updates, it clarifies that employers are responsible for considering the financial health of the annuity provider only at the time the guaranteed lifetime income product is offered—not into the future.

“Now that there is a workable safe harbor for plan sponsors, we are starting to see a lot more active interest in ways to incorporate guaranteed income annuities into the defined contribution plan,” says Rafaloff. “Plan sponsors are saying, ‘I’ve got to get my consultants on board and really start to understand the different solutions that are available.’”

The SECURE Act also will require plan administrators to provide to their DC plan participants illustrations of lifetime income projections for their plan assets. “Most plans are waiting for guidance from the Department of Labor on what those projections should look like,” Rafaloff explains. “For example, should you include potential future earnings or contributions?”

Up until now, employers’ retirement education efforts have been tilted toward helping participants build up their plan accounts. MetLife’s research showed that 83% of employers offer education and/or tools about adequately saving for retirement. Only 48% offer education and/or tools that focus on converting those savings into retirement income.

“The more education and the more tools that employers provide to their retiring employees, the more adoption of annuity products we see taking place,” says Rafaloff. “We have retirement plans that offer one-on-one advice and guidance, where financial reps sit down with people when they are getting ready to retire to talk about all the retirement benefits the company offers. That’s where we see employees being really committed and making the right decisions about how to use their assets to spend in retirement.

“For plan sponsors that are using a guaranteed lifetime income product, it is important to give employees as much flexibility as possible,” she continues. “For example, they need to have all the benefit forms that fit their specific situation. Do they need the income to last only for their lifetime? Do they want to protect their spouse in the event they should die early?

“It is also important to understand the idea of partial annuitization,” Rafaloff explains. “There’s this misconception that if an employee elects to utilize an annuity inside their 401(k) plan that they have to annuitize all the assets in their account. Nothing could be further from the truth. In fact, we strongly recommend that plan sponsors never require a plan participant to annuitize all of their money. We are all unique individuals with different income needs. We need to structure an income solution in a way that gives them freedom to best meet those needs.”

Employers’ efforts to educate employees on creating a lifetime retirement income can influence the all-important question of the employee’s retirement date. Retirement ages were already heading higher before the pandemic. Will the pandemic accelerate this trend?

Pre-pandemic, about a year ago, more than half of employers surveyed for MetLife’s study (57%) believed that their employees will retire at an older age than they were at that time. They expected the average retirement age of their workers to increase by 1.6 years over the following five years—from 64.5 to 66.1. Nearly one in five workers (19%) in the study said they didn’t know when they will retire; 43% expected to retire at age 65 or older.

The research found that since the financial crisis a decade earlier, employers have become more wary of the idea of workers pushing back their retirement date. Employers who said they are concerned about the effects of delayed retirements rose from 26% in 2009 to 43% in 2019.

“Ten years ago, employers were concerned about the ‘brain drain,’” says Rafaloff. “Today’s employers are increasingly worried about the impact of delayed retirement.”

At the same time, MetLife’s research found that employers (54%), workers (43%) and retirees (29%) support the idea of expanding the traditional idea of retirement to include some form of phased retirement. Generally, that would involve flexible or part-time work. It could include bridge jobs, gig work and encore careers (when companies recruit individuals over age 55, including those already retired, or talent that may have spent a period of time away from the workforce).

“The retirement model has evolved to become more fluid,” says Rafaloff. “There are more possibilities to transition from full-time work to full-time retirement. Employers are grappling with that trend and what it means for their business.”

For now, however, phased retirement appears to be more accepted in theory than practice, as 79% of employers are unsure whether they will offer it. Many employers cite regulatory and anti-discrimination concerns.

Regardless of when an employee retires, and whether it is traditional or transitional, they need guidance in converting their 401(k) balances to a sustainable income stream. Plan sponsors, brokers and insurers have an opportunity to help them do this by providing both counsel and product choices.

An annuity can be an important part of that mix. “It isn’t just an investment,” says Rafaloff. “It’s a guarantee.”

The author

Thomas A. McCoy, CLU, is an Indiana-based freelance insurance writer.