In a May 2010 paper: The Retirement Income Landscape, Vanguard Retirement Research Director Stephen P. Utkus and Gary R. Mottola, PhD explained the choices retirees must make when charting an investment strategy in retirement:
“Just as in their accumulation years, retirees seek to develop an investment strategy with a balance of return, risk, and cost suited to their unique circumstances.
“As the baby boomers get ready to take lump-sum distributions from workplace retirement plans, a new generation of products has emerged to help them meet the retirement income challenge.”
They noted two categories of income strategies that are currently available.
“To address investors’ retirement income needs, an array of investment, insurance, and banking products have emerged in the marketplace. One set of strategies is portfolio-based. These strategies do not provide guaranteed income streams, but use portfolio diversification and spending policies to manage certain elements of risk.
“A second set of strategies is based on annuity-type products and offers a guarantee. In exchange for some explicit or implicit cost, these strategies typically provide a fixed or variable level of income that is guaranteed for life.
"Portfolio-based: Income Investing, Systematic Withdrawal Plans (SWPs), Payout Funds
"Annuity-based: Immediate-income annuity, “Living-benefit” annuity"
We asked Steve Utkus, Vanguard Retirement Research Director about what plan sponsors are doing, or not doing, to address the need for retiree income solutions.
Chuck Miller: What has kept plan sponsors from offering more retirement income options?
Steve Utkus: Most sponsors are reluctant to add in-plan retirement income options for several reasons.
First, many retirement income products are new to the marketplace, and so need a longer track record of successful outcomes before they are likely to be offered in plans.
Second, many annuity-based programs involve undertaking a fiduciary evaluation of the creditworthiness of an insurer. Sponsors seem reluctant to take on this additional fiduciary duty.
Third, particularly for annuity-based programs, sponsors worry about their ability to switch products from insurer to insurer. The administrative flexibility is often not available if the sponsor changes their fiduciary judgment and decides to switch insurers. And finally, sponsors worry about low product take-up by participants.
CM: What are some of the options plan sponsors might consider?
SU: A simple solution for most sponsors is to ensure that they allow participants to set up a withdrawal plan from their plan account. In addition, they will need to work with their service provider to ensure that participants have adequate support -- in terms of education and/or advice -- to establish withdrawal programs. Sponsors can also offer in-plan required minimum distribution (RMD) services for older participants. Although RMDs are typically viewed as a tax law requirement, they can also be a simple way for older households to generate some income from their savings.
Sponsors might also consider annuity-based solutions for their plan. However, most sponsors are concerned about adding in-plan retirement options. Moreover, we don't foresee that most retirement income decisions will be made in the plan. Rather we anticipate that most of those decisions will be made in IRA rollover accounts -- in other words, most participants in retirement are likely to leave their employer plan. Thus, sponsors shouldn't necessarily feel pressured into adding options when most participants are likely to leave the plan and manage their retirement income options elsewhere.
CM: Some in government have been promoting the use of annuities. Why might they be beneficial and why aren’t they used more now?
SU: The classic argument for annuities is that they help participants protect against longevity risk -- the risk of living too long a life and running out of savings. By definition, in an annuity contract an insurer promises to make a regular income payment to the participant no matter how long he or she lives.
Annuities have not been particularly appealing retirement income solutions to individuals for several reasons. First, many view loss of access to savings -- the loss of liquidity -- with an annuity contract to be a major drawback. In exchange for an annuity income stream, an annuity investor loses permanent access to the amount invested. In the minds of many participants, having access to a pool of liquid savings in retirement, as a supplement to Social Security, seems a better way to manage risk in retirement than ceding control over those assets permanently to an insurer.
Second, there is the risk, though it is obviously small, of an insurer failing. The individual states in the U.S., which directly regulate insurers, provide certain guaranty fund arrangements in the event of a bankruptcy of an insurer. But there's still much uncertainty around these guarantees.
CM: Isn’t the real problem that plan participants just aren’t saving enough?
SU: I like to separate out the question of retirement savings adequacy from retirement income. Retirement income is the question of how a participant translates a given amount of assets into some income stream. Among the options available today in the marketplace are systematic withdrawal plans from a retirement account, payout funds, required minimum distributions from a retirement account, and various types of annuities. Participants still need help with translating assets into income whether they are well-prepared for retirement or not.