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This report was produced by the Advisory Council on Employee
Welfare and Pension Benefit Plans, usually referred to as the
ERISA Advisory Council (the “Council”). This report examines
the Spend Down of Defined Contribution Assets at Retirement. The
ERISA Advisory Council was created by ERISA to provide advice to
the Secretary of Labor. The contents of this report do not
represent the position of the Department of Labor (DOL).
The 2008 Council assigned a Working Group to examine and review
the Spend Down of Defined Contribution Assets at Retirement to
assess the issues and barriers facing:
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plan fiduciaries who wish to add plan design / investment
options for DC plans which provide lifetime income / periodic
payments at retirement,
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plan sponsors who wish to offer periodic income options as a
DC plan’s default distribution option, and
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DC plan participants as they attempt to evaluate the
tradeoffs between the traditional accumulation / lump sum
distribution model vs. alternative approaches that guarantee
periodic income levels at retirement.
The Working Group explored how DOL guidance or regulation can
enhance the retirement security of American workers by
facilitating access to and utilization of income (stream)
distributions from DC plans and expand on the success of PPA's
auto enrollment, contribution escalation and default investment
practices by incorporating similar concepts into the distribution
phase.
Testimony to the Working Group was provided on July 16, 2008
and September 10, 2008 by 22 speakers, representing employers,
financial advisors, investment managers, insurers, third-party
administrators, academics, organizations representing retiree
perspectives, attorneys/consultants, and the federal government.
After careful debate, consideration and analysis of the issues and
transcripts, the Council submits the following recommendations to
the Secretary of Labor for consideration:
Recommendation 1: Simplify the proposed annuity provider
selection rules and eliminate the requirement for an independent
expert – The proposed annuity provider selection rules currently
include 14 separate selection criteria for fiduciaries to
consider. The rules also explicitly require that, in those cases
where a fiduciary lacks the expertise to evaluate these criteria
on its own, the use of an independent expert is required to ensure
fiduciary protection. The use of an independent expert adds
additional cost barriers for the fiduciary who is considering
annuity options. Historically, independent experts have been
required only in those cases where conflicts of interest arise.
These extensive criteria, while offered as a safe harbor, are
perceived to create a substantially more stringent standard for
fiduciaries considering annuity investments vs. other investments.
The Council recommends that the proposed annuity provider
selection rule safe harbor be simplified by eliminating the eight
criteria contained in Section 2550.404a-4(c)(2) as well as the
independent expert requirement so that the fiduciary duties
involved in selecting an annuity provider are set forth in the
same manner and in the same detail as the duties involved in
prudently selecting an investment option, to which companies are
quite accustomed. The Council maintains that ERISA’s prudent
expert standard suggests that plan sponsors, whether or not
complying with a safe harbor, are required to exercise the same
prudence when selecting an annuity as is required to be exercised
in the selection of any other investment.
On October 6, 2008, the Department of Labor published final
regulations regarding the safe harbor for individual account plan
when selecting annuity providers. The final regulation (a.)
eliminates the eight criteria that had been listed in
2550.404a-4(c)(2),(b.) clarifies that a fiduciary may conclude
that it needs the assistance of an expert in selecting an annuity
provider, but eliminates the requirement that the expert be
independent , and (c.) states that the safe harbor does not
establish minimum requirements or the exclusive means for sponsors
seeking to satisfy their fiduciary responsibility when selecting
annuity providers. The Council believes that these changes have
substantially addressed the recommendation that resulted from
witness testimony to the satisfaction of the Council.
Recommendation 2: Update, Expand, and Amend Interpretive
Bulletin 96-1 - The Council recommends that the Department of
Labor expand the reach of IB 96-1 by adapting it to the spend-down
phase. As innovation continues in the financial marketplace and
greater numbers of retirees rely on DC plans as their primary
retirement vehicle, educational initiatives will need to address
items heretofore not necessarily addressed in IB 96-1. IB 96-1
needs to address information, education, and advice related to the
spend-down of retirement plan assets (distribution options,
in-plan vs. out of plan payments) as well as the accumulation of
those assets. Plan sponsors need clear guidance about the type of
information, programs and education they may provide to
participants, without being concerned that they are acting as a
fiduciary providing investment advice or that they may be exposed
to liability for breach of their fiduciary duty. Further, as
product innovation continues in this area, 96-1 needs to be
continually updated. This same recommendation was made by the 2007
Council that studied Financial Literacy.
Recommendation 3: Clarify the QDIA with respect to default
options incorporating guarantees that extend into the distribution
phase - The Council recommends that the Department of Labor
clarify that products which are eligible qualified default
investment alternatives (”QDIA”) while participants are
actively participating in the plan will continue to so qualify
when participants are in pay status if such investment products
are retained in the plan.
Such a clarification would confirm that fiduciaries receive the
same fiduciary protection under the QDIA regulation for amounts
that remain invested in guaranteed lifetime income products (that
otherwise satisfy the requirements of the regulation to be a QDIA
during the accumulation stage) during the spend-down phase of
participants’ accounts.
Recommendation 4: Encourage and Allow Additional Participant
Disclosure, Specifically the Conversion of Account Balances into
Annual Retirement Income - The Council recommends that the
Department of Labor encourage, authorize, endorse and facilitate
plan communications that use retirement income replacement
formulas based on final pay and other reasonable assumptions in
employee benefit statements on an individual participant basis.
Plan communications should facilitate an understanding of how much
income participant account balances will provide, that result in a
better understanding of how an account balance converts to annual
retirement income. The Department of Labor can facilitate this by
providing guidance to plan sponsors on best practices,
illustrative model notices as well as assumptions to convert
account balances into annual income streams. This builds upon a
similar recommendation made by the 2007 Council that studied
Financial Literacy.
Recommendation 5: Enhance plan sponsor and participant
education regarding the flexibility for distribution options - The
Council recommends that the Department of Labor publish and
regularly update information which provides useful guidance,
education and information to underscore the inherent flexibility
(and associated risks) available to participants in defined
contribution plans. This information should be directed to plan
participants as well as plan sponsors. Existing publications can
also be updated to discuss the relative merits of lump sums vs.
periodic payments, as well as the merits of leaving money in an
employer’s plan vs. establishing a rollover IRA.
Elizabeth Dill, Chair of the Working Group
Sanford Koeppel, Vice-Chair of the Working Group
Robert Archer
Edward Schwartz
Edward Mollahan
Dennis Simmons
Randy DeFrehn
Stephen McCaffrey
Mary Nell Billings
David Evangelista
Marc Le Blanc
Kevin Wiggins
Richard Helmreich
William Scogland, ex officio
Trisha Brambley, ex officio
The Council undertook a study on the Spend Down of Defined
Contribution Assets at Retirement. The balance of this report will
address the scope of the study, the questions for witnesses, dates
of testimony and list of witnesses, current environment for the
issues of inquiry, consensus recommendations to the Secretary of
Labor and summary of testimony from the witnesses.
The Council undertook this topic to discern standards and to
draft suggested recommendations for the ERISA Advisory Council for
the deliberation of the Secretary of Labor to take action as the
Secretary deems appropriate. The study focuses upon the types of
guidance that could help plan sponsors and plan participants make
better informed decisions regarding plan investment and insurance
vehicles that provide periodic or lifetime distributions. It also
focuses on how DOL guidance or regulation can enhance the
retirement security of American workers by facilitating access to
and utilization of income (stream) distributions from DC plans and
expand on the success of the Pension Protection Act of 2006’s (PPA)
auto enrollment, contribution escalation and default investment
practices by incorporating these behavioral inertia concepts and
fiduciary protections into the distribution phase.
Specifically, the study addresses whether:
-
Additional guidance, regulations or safe harbors could
provide plan fiduciaries assistance in choosing and offering
investment / insurance products designed to provide and/or
guarantee levels of periodic payout;
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Additional guidance, regulations or safe harbors could
facilitate broader availability and utilization of income options
by participants; and
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Additional guidance or regulations are needed to ensure that
appropriate advice and education can be provided/sponsored by the
employer to ensure effective participant decision-making regarding
not just accumulation of assets before retirement, but also the
spend down of assets during retirement.
The Council recognizes that participants may take distributions
upon separation from service that may be prior to retirement age.
This topic is focused on the spend-down of defined contribution
plan balances at retirement.
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What types of income streams should be available, and what
are the advantages and disadvantages to participants?
-
How do current practices in plan distribution design support
retirees’ abilities to manage income through retirement; how
could they be enhanced?
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What are the current obstacles to offering income options
vs. lump sums? Why do participants select lump sum options more
prevalently than periodic income options? How can these obstacles
be overcome?
-
What are the barriers to offering a default periodic
distribution option to participants who either leave balances in
the plan or who roll account balances out of plans? How can these
be overcome?
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What data is available, or that can be shared, regarding how
participants utilize account balances at retirement? Is there any
other data or studies that can provide insights into participant
financial decision making in preparation for retirement? What are
the key findings?
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With recent product innovations that tie retirement income
guarantees to contributions made during employment:
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What types of disclosures and information should a fiduciary
analyze when offering these options to participants?
-
What would need to be disclosed to participants to enable
them to make informed choices?
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What is the applicability (at what point do they apply, are
standards appropriate) of DOL’s proposed Selection of Annuity
Provider rules relative to options that have an accumulation
component and income guarantees at retirement? What additional
guidance is needed?
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What is the best manner to provide participants with
education about distribution options (including those that tie
income guarantees to investment elections during employment) and
the importance of these choices?
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What additional guidance could the DOL provide to plan
sponsors offering education related to distribution? Is additional
guidance required when the distribution option is tied to
investment elections during employment?
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What is the role of financial advisors? What are the
fiduciary issues that are presented when an employer / plan
sponsor offers 3rd party financial advice regarding decisions
related to accumulation / distribution? How can fiduciary issues
be mitigated? What might the DOL do to support plan sponsors who
provide this to participants?
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Should a future Council undertake a similar inquiry
regarding defined benefit plan distributions?
The scope of inquiry for the Working Group and the attendant
questions were given to all witnesses in advance of testimony. The
witnesses were told that the questions were merely a starting
point to generate thought and discussion on the study topic. The
questions were not intended to limit the parameters of testimony.
The Working Group solicited testimony of witnesses from
employers, financial advisors, investment managers, insurers,
third-party administrators, academics, organizations representing
retiree perspectives, lawyers/consultants, and the federal
government. The witnesses did not answer every question and in
many instances, there was not enough information presented to form
a consensus as to every inquiry by the Working Group.
The witnesses and the dates of their testimony were as follows:
July 16, 2008
Robert (Bob) Doyle, EBSA
Dallas Salisbury, Employee Benefit Research Institute
Neil Lloyd, Mercer Investment Consulting
Phil Suess, Mercer Investment Consulting
Jeff Fishman, JSF Financial, LLC
Frederick Conley, Genworth Financial
Mark Foley, Prudential Retirement
Jody Strakosch, MetLife, Institutional Income Annuities
Ann Combs, The Vanguard Group
Sarah Holden, Investment Company Institute
Douglas Kant, Fidelity Investments
Jason Chepenik, Chepenik Financial Services
David Wray, Profit Sharing/401k Council of America
Anna Rappaport, Anna Rappaport Consulting
September 10, 2008
Steven M. Saxon, Groom Law Group
Louis Mazawey, Groom Law Group
Joan Gucciardi, Summit Benefit & Actuarial Services
Jack Richie, Rogers Corporation
Allison
Klausner, Honeywell International on behalf of ABC
Alison Borland, Hewitt Associates
J. Mark Iwry, Retirement Security Project
Norman Stein, Pension Rights Center
Defined contribution plans have moved from being a supplemental
benefit to the primary employment-based retirement benefit for
most American workers. By the end of 2007, the amount of wealth in
tax-advantaged defined contribution plans, including IRA’s had
grown to $9.4 trillion.
Based upon 2005 Form 5500 filings, there were 631,000 defined
contribution plans covering 75 million participants. It is
estimated that only 25% of covered participants are in plans that
offer annuity features and utilization of annuities in those plans
is extremely low. In fact, recent research conducted by Hewitt
Associates LLC showed that over 90% of participants offered a lump
sum, take that option over an annuity distribution.
The Employee Benefit Research Institute’s (EBRI) “2008
Retirement Confidence Survey” showed that Americans’
confidence in their ability to afford a comfortable retirement had
dropped to its lowest level in seven years. Less than half of
workers surveyed indicated that they have tried to calculate what
they will need for a comfortable retirement. Savings levels are
modest, with 49% of workers reporting total savings and
investments of less than $50,000. Another study conducted by
Hewitt Associates indicated that fewer than 19% of workers will
have enough retirement income to meet 100% of their projected
needs.
In addition, the Society of Actuaries conducted a study, “Spending
and Investing in Retirement – is there a strategy?” The study’s
key findings indicated:
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Participants tend to be short-term focused
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Decisions are often made on an intuitive basis
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Investment strategies did not change much at the time of
retirement
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Changes in advisors represented (verb agreement) a
significant trigger for changing investments
Finally, there are numerous studies that show that life
expectancy is increasing. This means that many retirees are going
to live beyond the age for which they have saved.
All of these factors provide the backdrop against which the
next, and future generations of retirees will be financially
ill-prepared for retirement.
In two days of testimony, witnesses brought forth a number of
issues:
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Education is critical to ensuring adequate income in
retirement.
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Most participants are not well-equipped to manage the
spend-down of their defined contribution plan assets. Yet plan
sponsors are concerned about the distinction between education and
advice and the related potential exposure, particularly as it
relates to the spend down phase.
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Many participants are not adept at translating an account
balance into the amount of income it will provide.
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The Department of Labor’s publications, like “Taking the
Mystery Out of Retirement Planning” are a good start, but
incomplete.
-
Many plans do not offer annuities or periodic distribution
options. Many of the innovations that include retirement income
guarantees are wrapped around or included in traditional and
non-traditional (e.g. target date / life cycle funds) investment
options. There is concern that the QDIA protections afforded to
plan sponsors during the accumulation phase, do not extend to the
distribution phase.
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Many witnesses testified that the annuity provider selection
rules create a higher fiduciary hurdle for sponsors interested in
adding annuity-type investments to their defined contribution
plans.
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Some witnesses testified about the confusion whether the
decision to add alternative distribution options (vs. selection of
the annuity provider) is a fiduciary or “settlor” decision.
-
Some witnesses noted that pre-retirement withdrawals are
causing “leakage” from defined contribution plans,
compromising the ability of the plans to provide retirement
income.
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Many witnesses suggested a number of reforms that could be
made to the tax qualified plan rules administered by the Treasury
Department/IRS that would help facilitate the implementation and
utilization of guaranteed lifetime income forms of distributions.
They felt that the DOL could serve as a catalyst in achieving the
necessary cross agency collaboration required to help ensure that
retirement plan asset spend down would be better aligned with
retiree income security.
The following provides more detail on each of these issues:
A common thread that ran through the testimony of several
witnesses indicated that plan sponsors need clear guidance about
the type of information, programs and education they may provide
to participants without being characterized as a fiduciary
providing investment advice or without exposing themselves to
liability for breach of their fiduciary duty. Further, as product
innovation continues in this area, 96-1 needs to be continually
updated.
Review of Interpretative Bulletin 96-1
Under ERISA Interpretative Bulletin 96-1 (“IB 96-1”), a
plan sponsor may avoid ERISA fiduciary liability while providing
general investment education and information to participants in a
plan that permits self-directed investments, if the sponsor
prudently selects and monitors the educator. DOL issued IB 96-1 in
response to concerns about whether providing such information
might be considered “investment advice” under the definition
of “fiduciary” in ERISA § 3(21)(A)(ii). Under this provision,
a person is a plan fiduciary to the extent she renders investment
advice about the plan's assets in exchange for compensation. IB
96-1 was intended to encourage group or individual counseling to
plan participants in a manner that is tax-free to recipient
employees, deductible by employers, and sanctioned by IRS ( Code
Sec. 132(m) ) and DOL (Interpretative Bulletin 96-1). See
September 10, 2008 testimony of Steve Saxon, Esq. Groom Law Group.
See also, T. Brion “Consumer-Driven” Retirement Plans—Their
Evolution and Opportunities (08/16/2004 - Volume 10, No. 35) PBW
Practitioner Planning Articles (RIA)
Permitted investment and financial information includes:
general financial and investment concepts; tax deferral; historic
rates of return among asset classes; inflation effects; estimated
retirement income needs; investment time horizons; risk tolerance;
and asset allocation. More specifically, there are four categories
of information or safe harbors.
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Plan Information. This safe harbor protects dissemination of
information and materials that explain the benefits of plan
participation, the benefits of increasing contributions, and the
impact of pre-retirement withdrawals on post-retirement income,
plan terms, or plan operations. See also Labor Reg. §
2550.404c-1(b)(2)(i). The sponsor must offer this information
without reference to the appropriateness of any individual
investment option for a participant.
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Investment and Financial Information. A sponsor may offer
general financial and investment concepts such as risk and return,
diversification, dollar-cost averaging, compounding returns, tax
deferred investing, historical rates of return derived from
standard market indices, effects of inflation, estimating future
retirement needs, determining investment time horizons, and risk
tolerance. This kind of information is permissible if the
information bears no direct relationship to investment
alternatives available under the plan.
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Asset Allocation Models. A sponsor may disseminate
information on asset allocation, including models of asset
allocation portfolios of hypothetical individuals with different
time horizons and risk profiles. These models must be firmly
grounded in accepted investment theories. Disclosure is mandatory
and must specify all material facts and assumptions underlying the
models. Information and materials may include, for example, pie
charts, graphs, or case studies. There must be a statement
indicating that, in applying particular asset allocation models,
participants should consider their other assets, income, and
investments (e.g., home equity, other retirement plans, savings)
in addition to their interest in the plan;
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Interactive Materials. Permissible interactive materials
include questionnaires, worksheets, software and similar materials
that estimate future retirement income needs, provided that
requirements - similar to those for asset allocation (the third
safe harbor, above) - are met.
Safe harbor treatment applies regardless of who provides the
information, how often it is shared, the form in which it is
provided (e.g. writing, software, video or in a group or
one-on-one) or whether a category of information and materials is
furnished alone or along with other categories of information and
materials. Note that “safe harbors” apply only to accumulation
tools, although there is mention of tools made available to
estimate future income needs.
In IB 96-1, the DOL states that there may be many other
examples of information, materials and educational activities that
would not be investment advice. DOL cautions against drawing
inferences from the safe harbors with respect to whether the
furnishing of information, materials or educational activities not
described therein could constitute the provision of investment
advice.
Moreover, the DOL warns that the determination as to whether
the provision of any information, materials or educational
services not described in 96-1 constitutes investment advice must
be determined under the criteria of Labor Reg. § 2510.3-21(c)(1).
This regulation relates to the provision of investment advice to a
benefit plan and the circumstances under which a person becomes a
fiduciary because of advice on the advisability of investing in
particular vehicles or where a person has indirect or direct
discretion to implement the advice.
Although courts may take into account DOL's view, as expressed
in IB 96-1, courts are not bound to follow an Interpretive
Bulletin, particularly if the IB is found not to fall exclusively
within the scope of the law of qualified plans, nor when it is not
issued as a regulation, per se. Bussian v. RJR Nabisco, Inc., 223
F.3d 286 (5th Cir. 2000).
The Council heard testimony from a variety of witnesses
regarding the problems associated with participants’ lack of
understanding of how their account value translates into a monthly
income stream. For example: Anna Rappaport noted that “As a
society we do not think of the balances as related to retirement
income.” Similarly, Mercer’s Phil Suess expressed concern that
most employees do not understand: “…1) the amount of assets
they will need in retirement; 2) the amount of contributions
necessary to accumulate sufficient assets; 3) the earnings needed
on their contributions; and 4) how to invest their assets to have
a reasonable probability of adequate earnings. In the spend-down
phase, participants: 1) fail to grasp longevity risk; 2) remain
disinterested in investments; and 3) prefer to delegate
decision-making to third parties. Experience shows the success of
educating participants to make informed decisions has been
disappointing at best.”
It was noted that the 2007 ERISA Advisory Council had formed a
Working Group on Participant Benefit Statements (the Working
Group) to study changes to the reporting and disclosure
requirements applicable to all pension plans, specifically
requiring benefit statements to be furnished to plan participants
in all defined benefit and defined contribution plans required by
the Pension Protection Act of 2006 and to make recommendations to
the DOL regarding the required content, form and timing of the
benefit statements. In pertinent part, that group recommended:
“….The Department should convene a Task Force of benefit
statement stakeholders to develop the content of a model
statement. The view of the Working Group is that the content
should be minimized, including only that required by the statute.
The model statement should be crafted in a way to inspire sponsors
to add information and education.”
Nevertheless, Jason K. Chepenik, observed that … “Many
retirees are faced with managing a large sum of money far in
excess of their former incomes, without a clear understanding of
how to make it last through retirement. Bad decision making often
results from this lack of understanding. Current gap analytics
tend to use assumptions that are no longer based in reality,
estimating living expenses at 70-85% of pre-retirement, and
inflation at 3-4%. In reality, higher costs faced by retirees,
particularly in the area of health costs, tend to skew both
numbers significantly higher.” To address that problem, J. Mark
Iwry stated that … “Plan sponsors should be required to
present benefits as an income stream of monthly or annual lifetime
payments, in addition to presenting the benefits as an account
balance in accordance with current practice.”
Mercer Investment Consulting’s Neil Lloyd concurred,
commenting that plans should “Provide income projections on
statements from pension plans and rollover accounts” (although
the basis of projections can be a problem). Taken in totality, the
Council concluded that a sufficient case has been made to suggest
a course of action, as shown in Recommendation Number 4 (below),
that goes beyond the recommendation of the 2007 Council by
suggesting to the Department that it is appropriate to encourage
plan sponsors to include information relative to the income stream
that can be provided in retirement from the account balance in
their 401(k) or other defined contribution plan.
Several witnesses mentioned the Department of Labor’s
publication, “Taking the Mystery Out of Retirement Planning,”
and observed that this could incorporate more information and
education regarding distribution options at retirement. Currently,
“Taking the Mystery Out of Retirement Planning” is available
on the EBSA Web site, and is an online document that includes
interactive worksheets. The publication provides support to
employees evaluating the decision to retire and includes:
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An overview of how to track down monies owed in retirement,
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Tools to estimate post-retirement expenses,
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Comparisons of expenses and income with suggestions to close
the gap
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Tactics to make retirement money last, and
-
Links to resources that can provide additional guidance to
pre/post-retirees.
Several testified that “Taking the Mystery Out of Retirement
Planning” could be modified to address the benefits of utilizing
in-plan periodic distribution options. Additionally, there was
testimony that the DOL could provide more education for plan
sponsors regarding the ability to offer more flexible distribution
approaches (e.g. partial lump sum distributions), that would
facilitate participants’ ability to realize some of the benefits
of leaving their retirement monies in the plans.
Under ERISA, fiduciaries of participant-directed defined
contribution plans are not liable for losses when participants or
beneficiaries exercise control of the investment of their
accounts, if the plan satisfies the requirements of ERISA section
404(c). In general, plan fiduciaries retain fiduciary liability
for any loss or breach that results from investing assets in a
participant’s account when a participant does not exercise
control over investments.
Under the Pension Protection Act of 2006 (PPA), plan
fiduciaries of participant-directed defined contribution plans
will receive relief from fiduciary liability for default
investments, as long as they comply with the Department of Labor (DOL)
rules for these investments. These rules:
-
Require certain conditions to be met to obtain the fiduciary
protection,
-
Authorize certain types of investment products as qualified
default investment alternatives (“QDIAs”); and
-
Require plans to provide both an initial notice and an
annual notice to participants and beneficiaries whose assets are
being invested in a QDIA.
The fiduciary relief provided in the final rules applies to
situations where participants or beneficiaries have not exercised
control over the investments in their accounts.
The relief provided by these rules is similar to the fiduciary
relief that applies to participants or beneficiaries who exercise
control over their investments in plans. In other words, if
employers comply with these rules, investments in QDIAs will be
considered to have been “directed” by participants.
A QDIA must meet five specific requirements. The one
requirement relevant to the Council’s topic is that a QDIA must
be one of the following permissible investment types:
-
A product with a mix of investments (equities and fixed
income) that takes into account an individual’s age or
retirement date, e.g. target date or lifecycle funds;
-
A product with a mix of investments (equities and fixed
income) that takes into account the characteristics of all
participants, rather than individuals, e.g. balanced funds;
-
An investment service that allocates contributions among
existing plan options to provide an asset mix that takes into
account an individual’s age or retirement date e.g. managed
accounts; and
-
A capital preservation product (such as a money market
account) for just the first 120 days of an individual’s plan
participation. Before the end of the 120-day period, the plan must
transfer the participant’s assets into an acceptable QDIA, as
described above, unless the participant redirected investments
during this period or withdrew accidental deferrals during the
first 90 days of participation.
Even though fiduciary relief is provided only if one of the
investment alternatives described above is used as the default
investment alternative, it is important to note that the DOL
acknowledges that the use of other investment alternatives may
still be prudent. For example, investments in money market funds,
stable value products and similarly performing investments may be
prudent for some participants and beneficiaries, even though those
investments are not QDIAs. Additionally, the regulation states
that an investment fund, product or model portfolio that otherwise
meets the QDIA requirements is eligible to be a QDIA even though
it is offered through variable annuity or similar contracts or
through common or collective trust funds or pooled investment
funds and without regard to whether the contract or fund provides
annuity purchase rights, investment guarantees, death benefit
guarantees or other features ancillary to the investment fund,
product or model portfolio.
The Council understands that increasingly plan sponsors
designate as the plan’s QDIA a target maturity fund product that
contains a guarantee or guarantees issued by an insurance company.
The plan sponsor would rely on Section 2550.404c-5(e)(4)(vi) of
the QDIA regulation which states “an investment fund, product or
model portfolio that otherwise meets the requirements of this
section shall not fail to constitute a product or portfolio for
purposes of paragraph (e)(4)(i) or (ii) of this section solely
because the product or portfolio is offered through variable
annuity or similar contracts or through common or collective trust
funds or pooled investment funds and without regard to whether
such contracts or funds provide annuity purchase rights,
investment guarantees, death benefit guarantees or other features
ancillary to the investment fund, product or model portfolio” to
support the qualification of the contract as a QDIA during the
active participation or accumulation phase.
However, the Council believes that there is significantly less
certainty about the status of the contract as a QDIA when the
contract continues in effect after a participant’s retirement
during the distribution phase. This uncertainty exists if the
participant makes an affirmative election to take a lifetime
income stream of payments or in those cases in which the plan’s
terms provide that the income stream is triggered automatically
(in the absence of an affirmative election to the contrary by a
participant to receive a different form of distribution offered by
the plan).
For this purpose, the Council assumes that a plan sponsor has
determined that it is prudent to utilize a specific provider’s
contract and is otherwise satisfied that it has discharged its
fiduciary responsibilities with respect to the selection and
on-going monitoring of the provider.
Testimony before the Council revealed concern about the
complexity and detail surrounding the DOL’s current annuity
selection criteria. The following is background of the applicable
rules related to annuity distributions from defined contribution
plans.
DOL annuity selection standards. Under the PPA, Congress
directed the DOL to issue regulations clarifying that the
selection of an annuity contract as an optional form of
distribution from a defined contribution plan is not subject to
the safest available annuity standard under DOL Interpretive
Bulletin 95-1. Further, the DOL was to confirm that the selection
is subject to all otherwise applicable ERISA fiduciary standards
(Section 625 of PPA).
In response, in November of 2007 the DOL issued an interim
final rule in response to the Congressional directive enacted in
PPA. In addition, the DOL issued a proposed regulation that
provides a safe harbor for defined contribution plan fiduciaries
when selecting an annuity provider and purchasing an annuity. This
safe harbor contained a number of conditions that a fiduciary must
satisfy in order to get the safe harbor protection. Specifically,
the proposed regulation provides that the fiduciary should:
-
Engage in an objective, thorough and analytical search for
the purpose of identifying and selecting providers from which to
purchase annuities;
-
Determine either that the fiduciary had, at the time of the
selection, the appropriate expertise to evaluate the selection or
that the advice of a qualified, independent expert was necessary;
-
Give appropriate consideration to information sufficient to
assess the ability of the annuity provider to make all future
payments under the annuity contract;
-
Appropriately consider the cost of the annuity contract in
relation to the benefits and administrative services to be
provided under such contract;
-
Appropriately conclude that, at the time of the selection,
the annuity provider is financially able to make all future
payments under the annuity contract and the cost of the annuity
contract is reasonable in relation to the benefits and services to
be provided under the contract; and
-
In the case of an annuity provider selected to provide
multiple contracts over time, periodically review the
appropriateness of the conclusion described above.
In addition, the DOL provided eight additional factors that a
fiduciary must consider for purposes of showing that the
fiduciary: gave appropriate consideration to information
sufficient to assess the ability of the annuity provider to make
all future payments under the annuity contract; and appropriately
considered the cost of the annuity contract in relation to the
benefits and administrative services to be provided under such
contract. These factors the fiduciary must consider are:
-
The ability of the annuity provider to administer the
payments of benefits under the annuity to the participants and
beneficiaries and to perform any other services in connection with
the annuity, if applicable;
-
The cost of the annuity contract in relation to the benefits
and administrative services to be provided under such contract,
taking into account the amount and nature of any fees and
commissions;
-
The annuity provider’s experience and financial expertise
in providing annuities of the type being selected or offered;
-
The annuity provider’s level of capital, surplus and
reserves available to make payments under the annuity contract;
-
The annuity provider’s ratings by insurance ratings
services. Consideration should be given to whether an annuity
provider’s ratings demonstrate or raise questions regarding the
provider’s ability to make future payments under the annuity
contract;
-
The structure of the annuity contract and benefit guarantees
provided, and the use of separate accounts to underwrite the
provider’s benefit obligations;
-
The availability and extent of additional protection through
state guaranty associations; and
-
Any other information that the fiduciary knows or should
know would be relevant to evaluating the annuity provider’s
ability to make all future payments and the relationship between
the costs and the benefit and administrative services to be
provided under the annuity contract.
Several witnesses expressed concern that, taken as a whole,
these 14 separate factors are difficult to satisfy completely. The
rules also explicitly require that, in those cases where a
fiduciary lacks the expertise to evaluate these criteria on its
own, the use of an independent expert is required to ensure
fiduciary relief. Historically, independent experts have been
required only in those cases where conflicts of interest arise. In
addition, some witnesses expressed the concern that, although the
proposed regulation is designed to be a safe harbor, having these
detailed and somewhat complex criteria “on the books” may
create a higher fiduciary hurdle for plan sponsors who may be
interested in adding an annuity distribution option to their plan,
thus deterring some plans from adding the option.
Witnesses suggested that even though the annuity selection
rules provide a “safe harbor”, they create a framework which
suggests a more stringent set of criteria to meet fiduciary
requirements when selecting annuity providers. They suggested that
either the safe harbor rules be modified to reflect the same
fiduciary standard applied to other investments, or at least be
scaled back – for example, eliminating the eight additional
factors.
On October 6, 2008, the Department of Labor published final
regulations regarding the safe harbor for individual account plan
when selecting annuity providers. The final regulation (a.)
eliminates the eight criteria that had been listed in
2550.404a-4(c)(2) ) (the 8 criteria outlined above), (b.)
clarifies that a fiduciary may conclude that it needs the
assistance of an expert in selecting an annuity provider, but
eliminates the requirement that the expert be independent , and
(c.) states that the safe harbor does not establish minimum
requirements or the exclusive means for sponsors seeking to
satisfy their fiduciary responsibility when selecting annuity
providers. The Council believes that these changes have
substantially addressed the recommendation that resulted from
witness testimony.
During the course of testimony, there was some discussion
regarding whether adding an annuity option to, or making it the
default distribution in a defined contribution plan, is a “settlor”
or fiduciary function.
The Council heard testimony from Robert Doyle, of the
Department of Labor, that it is the Department’s view that
certain decisions to offer distribution options or choices that
are intended to provide or increase the likelihood of lifetime
income for retirees are made by a plan sponsor as a matter of plan
design and are “settlor” (as opposed to fiduciary) in nature.
The Department also has consistently taken the position that
the implementation of such a provision, such as the duty to
prudently select and monitor the provider of a guaranteed lifetime
income product, would always be subject to fiduciary
responsibility requirements.
It is important for plan sponsors who are considering adding
guaranteed lifetime income as a plan distribution option, or
making it the plan’s default distribution choice, to understand
this distinction. It is anticipated and the Council believes that
the clarity with which the Department delineated this position in
its testimony has addressed any remaining uncertainty about plan
sponsors’ roles and responsibilities in this area. This may lead
to greater dissemination and utilization of these types of
distribution choices.
In other words, the addition of an annuity distribution option
is a plan design decision, and therefore a “settlor” function.
The selection of an annuity provider is a fiduciary function.
Several witnesses testified that solutions for income adequacy
in retirement, tied to the issue of spend down of retirement
assets, cannot ignore the issue of “leakage” during the
accumulation of retirement assets. Leakage is defined as the
outflow of monies from a defined contribution plan prior to
retirement. There are a number of ways in which leakage occurs:
-
Hardship withdrawals
-
Loans
-
Distributions upon termination of employment, but prior to
retirement, where there is no rollover
-
In-service withdrawals
-
70½ distributions
-
Access to retirement plan balances when a sponsor terminates
a plan.
Many witnesses testified that revisions to the Qualified Joint
and Survivor Annuity rules covered in Internal Revenue Code
Section 417 would facilitate broader offering of annuity options
in plans. Many observed that compliance with the rules attendant
to obtaining spousal consent is a barrier for many sponsors
considering life annuity options in defined contribution plans.
Authorizing the use of electronic technology such as electronic
notarization would ease the manner in which spousal consent is
obtained and addresses one significant concern. Some urged that
consideration be given to DOL and Treasury sponsoring legislation
to extend the spousal consent rules to lump sum distributions so
as to level the playing field for selection of all distribution
options in defined contribution plans or amending the qualified
plan rules to require all tax favored retirement plans to offer a
guaranteed lifetime income form of distribution.
Additionally, many of the issues related to “leakage”
(in-service distributions, 70½ distributions, stock
distributions and loans) are under the purview of the Department
of Treasury and the Internal Revenue Service.
Therefore, many recommended that the Department of Labor take
the lead to promote cross agency collaboration in the hope that
such action would lead to greater reflection, focus and
consideration of these retirement security issues.
Introduction
The Council posited a number of questions to exploring how the
DOL guidance or regulation could enhance the retirement security
of American workers by faciliatating access to and utilization of
income stream distributions from defined contribution plans.
Three of our consensus recommendations ask for some changes to
regulations and other publications such as interpretive bulletins.
The Council believes that:
-
simplification to the “safe harbor” annuity provider
selection rules would result in a greater number of sponsors
considering implementation of annuity and/or guaranteed periodic
income options.
-
updates to IB 96-1 which delineate between and among
information, education and advice related to the spend down-phase
will promote more informed decision making by participants. As new
products, strategies and techniques require new choices and
decisions by plan participants, they will look to their plan
sponsors for help. Changes to IB 96-1 were also recommended by the
2007 Council that studied Financial Literacy.
-
clarification that QDIA fiduciary protection continues to be
applicablee during the spend-down phase of participant accounts
will result in greater availability of income guarantees for
participants in the spend-down phase.
The remaining two recommendations focus on the ways in which
broad education can be provided to participants. The Department of
Labor has the ability to influence plan sponsors short of formally
changing the written law or regulations. Specifically, the Council
would like the Department of Labor to:
-
Encourage, endorse and authorize for use on a per
participant basis, retirement income replacement measurements
-
Continue to publish materials for participant and sponsor
oriented education. The Department of Labor can continue to refine
its educational magazines/pamphlets addressing financial needs
analysis and financial decision-making. It can also educate
sponsors on the ‘best practices’ of assisting employees/plan
participants plan for the receipt of retirement income and the
various alternatives available to them.
Recommendation 1: Simplify the proposed annuity selection rules
and eliminate the requirement for an independent expert – The
proposed annuity selection rules currently include 14 criteria for
consideration when selecting an annuity provider. To ensure
fiduciary relief, the rules also explicitly require the use of an
independent expert in those instances where the fiduciary lacks
the expertise to evaluate these criteria on its own. The use of an
independent expert also adds additional cost barriers for the
fiduciary who is considering annuity options. It is customary to
require independent experts only in those cases where a conflict
of interest has arisen. These extensive criteria, while offered as
a safe harbor, are perceived to create a more stringent standard
for fiduciaries considering annuity investments vs. other
investments. The Council recommends that the proposed annuity
selection rules be simplified so that the fiduciary duties
involved in selecting an annuity provider are set forth in the
same manner and in the same detail as the duties involved in
selecting an investment option, to which companies are quite
accustomed. The Council maintains that the prudence requirements
suggest that plan sponsors, whether or not complying with a safe
harbor, are required to exercise the same prudence when selecting
an annuity as with any other investment.
On October 6, 2008, the Department of Labor published final
regulations regarding the safe harbor for individual account plan
when selecting annuity providers. The final regulation (a.)
eliminates the eight criteria that had been listed in
2550.404a-4(c)(2), (b.) clarifies that a fiduciary may conclude
that it needs the assistance of an expert in selecting an annuity
provider, but eliminates the requirement that the expert be
independent , and (c.) states that the safe harbor does not
establish minimum requirements or the exclusive means for sponsors
seeking to satisfy their fiduciary responsibility when selecting
annuity providers. The Council believes that these changes have
substantially addressed the recommendation that resulted from
witness testimony
Recommendation 2: Update, Expand, and Amend 96-1 - The Council
recommends that the Department of Labor expand the reach of IB
96-1 with updates that include educational initiatives needed to
anticipate innovations in the financial marketplace. IB 96-1 needs
to address information, education, and advice related to the spend
down of retirement plan assets (distribution options, in-plan vs.
out of plan payments) as well as the accumulation of those assets.
Further, as innovation continues in this area, IB 96-1 needs to be
continually updated.
The Council believes that retirement and distribution options
are effectively communicated to retiring and withdrawing
participants in terms of timing, media and content. However, the
Council heard from many witnesses that there is an “information
gap” that exists between the participants receiving qualified
plan distributions and plan sponsors. Specifically, the Council
finds plan participants are not afforded access to decision making
tools that effectively facilitate individual management of
retirement plan assets. Finally, the Council believes that the
reason for the information gap is primarily the confusion that
exists at the plan sponsor level concerning the potential exposure
to fiduciary liability for tools or information provided to assist
plan participants on plan distributions.
The Council believes that neither the DOL nor employers need
provide any new brochures, worksheets, or pamphlets etc. for
participants. Instead, the Council suggests that regularly
scheduled, constant vigilance of marketplace innovation be
reflected in possible future regulatory relief and clarity being
afforded in follow-up pronouncements to Interpretive Bulletin 96-1
pertaining to retirement income planning, keeping that Bulletin
timely and relevant.
In witness testimony, the Council heard that numerous factors
have led to a complex, specialized financial services marketplace
requiring plan participants to be actively engaged in order to
manage their finances effectively. Driven by increased
competition, the forces of market technology and market innovation
have resulted in a sophisticated industry in which plan
participants are offered a broad spectrum of services by a wide
array of vendors. Compelling regulatory issues, such as predatory
marketing and suitability of products, have also added to a sense
of urgency regarding financial literacy in a ‘participant-directed’
world.
The “safe harbors” of IB 96-1 are accumulation tools. Safe
harbor treatment applies regardless of who provides the
information, how often it is shared, the form in which it is
provided (e.g. writing, telephone, internet, software, video or in
a group or one-on-one) or whether an identified category of
information and materials is furnished alone or in combination
with other identified categories of information and materials.
In IB 96-1, the DOL noted that information and materials
described in the four graduated safe harbors detailed within the
bulletin merely represent examples of the type of information and
materials that may be furnished to participants without such
information and materials constituting “investment advice” for
purposes of the definition of “fiduciary” under ERISA Sec.
3(21)(A)(ii).
The first of the safe harbors under IB 96-1 states that
providing information and materials that inform a participant or
beneficiary about the benefits of plan participation, the benefits
of increasing plan contributions, the impact of pre-retirement
withdrawals on retirement income, the terms of the plan, or the
operation of the plan that are made without reference to the
appropriateness of any individual investment option for a
participant or beneficiary will not be considered the rendering of
investment advice.
The second safe harbor of IB 96-1 states that general financial
and investment concepts such as risk and return, diversification,
dollar cost averaging, compounded return and tax deferred
investing, historical rates of return between asset classes based
on standard market indices, effects of inflation, estimating
future retirement needs, determining investment time horizons,
risk tolerance, provided that the information has no direct
relationship to investment alternatives available under the plan.
The third safe harbor of IB 96-1 allows asset allocation
information to be made available to all participants and
beneficiaries - providing participants with models of asset
allocation portfolios of hypothetical individuals with different
time horizons and risk profiles. These models must be based on
accepted investment theories. All material facts and assumptions
on which the models are based must be specified, and disclosures
are mandated.
The fourth safe harbor of IB 96-1 allows interactive investment
materials such as questionnaires, worksheets, software and similar
materials that provide participants a means of estimating future
retirement income needs, provided that requirements similar to
those for asset allocation (above) are met.
Further, in IB 96-1, the DOL stated that there may be many
other examples of information, materials and education services
which, if furnished to participants would not constitute the
provision of investment advice. Accordingly, the DOL advises no
inferences should be drawn from the four graduated safe harbors
with respect to whether the furnishing of information, materials
or educational services not described therein could constitute the
provision of investment advice. The DOL cautions that the
determination as to whether the provision of any information,
materials or educational services not described in IB 96-1
constitutes the rendering of investment advice must be made by
reference to the criteria of Labor Reg. Sec. 2510.3-21(c)(1). That
regulation establishes the criteria for deeming the rendering of
investment advice to an employee benefit plan. Specifically,
investment advice is rendered where recommendations are provided
as to the advisability of investing in particular vehicles and
whether the person has indirect or direct discretion to implement
such advice.
The Council believes that as the Baby Boom Generation moves
into the de-cumulation phase – i.e. asset accumulation
demographically shifting toward income planning – IB 96-1 will
need to be amended, updated and expanded to stay relevant within
the regulatory construct viz a viz the innovative marketplace. By
way of example, while ‘retirement calculators’ are ‘educational’
under 96-1, it should be contemplated and communicated that
regulatory relief extend to advising plan participants concerning
mandatory 20% tax withholding, early withdrawal 10% tax,
guaranteed income for life, outliving income stream et. al.
The Council believes that the recommendations for clarity and
relief are applicable not only to single-employer plans, but also
to multiemployer plans.
Recommendation 3: Clarify the QDIA with respect to default
options incorporating guarantees that extend into the distribution
phase - To further help plan sponsors and fiduciaries better understand
their obligations and responsibilities and avail themselves of
appropriate and available protections relative to offering
lifetime income distributions, the Council believes that it would
be useful for the DOL to clarify that products which qualify as
qualified default investment alternatives (”QDIA”) while
participants are active will continue to so qualify when
participants are in pay status if such investment products are
retained in the plan. Such a clarification would confirm and
clarify that fiduciaries receive the same fiduciary protection
under the QDIA regulation for amounts that remain invested in
guaranteed lifetime income products (that otherwise satisfy the
requirements of the regulation to be a QDIA during the
accumulation stage) during the spend-down phase of participants’
accounts.
The Council understands that it is common practice for a plan
sponsor to designate, as the plan’s QDIA, a target maturity fund
product that contains a guarantee or guarantees issued by an
insurance company. The plan sponsor would rely on Section
2550.404c-5(e)(4)(vi) of the QDIA regulation which states, “an
investment fund, product or model portfolio that otherwise meets
the requirements of this section shall not fail to constitute a
product or portfolio for purposes of paragraph (e)(4)(i) or (ii)
of this section solely because the product or portfolio is offered
through variable annuity or similar contracts or through common or
collective trust funds or pooled investment funds and without
regard to whether such contracts or funds provide annuity purchase
rights, investment guarantees, death benefit guarantees or other
features ancillary to the investment fund, product or model
portfolio” to support the qualification of the contract as a
QDIA during the active participation or accumulation phase.
However, the Council believes that there is significantly less
certainty about the status of the contract as a QDIA if the
contract were to continue in effect after a participant’s
retirement during the distribution phase through the exercise of
annuity purchase right features. This uncertainty exists if the
participant makes an affirmative election to take a lifetime
income stream of payments or in those cases in which the plan’s
terms provide that the income stream gets triggered automatically
(in the absence of an affirmative election to the contrary by a
participant to receive a different form of distribution offered by
the plan).
For this purpose, the Council assumes that a plan sponsor has
determined that it is prudent to utilize a specific provider’s
contract and is otherwise satisfied that it has discharged its
fiduciary responsibilities with respect to the selection and
on-going monitoring of the provider.
The Council believes that plan sponsors and fiduciaries would
be encouraged to offer these products and utilize these features
with greater frequency if they had greater confidence that QDIA
protection were available in the distribution phase.
While the Council believes that the most typical situation for
which a clarification of the QDIA regulations would be helpful
involves defaulting retiring participants into the guaranteed
lifetime income distribution feature of a QDIA, the Council is
aware of other situations involving distributions of plan benefits
in the form of guaranteed lifetime income where QDIA protection
should be available and additional clarifications by the
Department are warranted. These include the following situations:
1) participants’ accounts are not invested in the contract
during the accumulation phase but are placed into this choice at
the time distributions commence; 2) participants terminate
employment prior to retirement but their funds remain in the plan
and regardless of how the funds were invested prior to the time
distributions commence, the funds are placed into a guaranteed
lifetime income product meeting the QDIA requirements at the time
a distribution takes place under the plan; and 3) the plan
provides that only a part of participants’ funds are defaulted
into an income product.
Recommendation 4: Encourage and Allow Additional Participant
Disclosure, Specifically the Conversion of Account Balances into
Annual Retirement Income - The Council recommends that the
Department of Labor encourage, allow and facilitate plan
communications that use retirement income replacement formulas and
final pay multiples in employee benefit statements on a personal
participant basis. Plan communications should facilitate an
understanding of how much income participant account balances will
provide, that result in a better understanding of how an account
balance converts to annual retirement income. The Department of
Labor can facilitate this by providing guidance to plan sponsors
on best practices, generating illustrative model notices, as well
as assumptions to convert account balances into annual income
streams. This builds upon a similar recommendation was made by the
2007 Council that studied Financial Literacy.
Recommendation 5: Enhance plan sponsor and participant
educations regarding the flexibility for distribution options -
The Council recommends that the Department of Labor publish and
regularly update information which provides information which
underscores the inherent flexibility available to participants in
defined contribution plans. Existing publications can also be
updated to discuss the relative advantages of lump sums vs.
periodic payments, as well as the advantages of leaving money in
an employer’s plan vs. establishing an IRA.
David Wray, Profit Sharing/401(k) Council of America
David Wray addressed the Council in his capacity as President
of the Profit Sharing/401(k) Council of America (PSCA), a national
association of employers who sponsor defined contribution
retirement plans. He discussed the assets held and projected to be
held in defined contribution accounts through 2015. The magnitude
of DC plan assets held naturally draws significant interest from
policymakers, employers and financial service providers. He
cautioned that regulators and lawmakers to resist the general
inclination to recommend statutory or regulatory changes that
would dampen development of new processes and products as baby
boomers retire.
DC plans are vehicles for building retirement wealth. However,
Mr. Wray contextualized how DC plan assets fit in with the annuity
benefits paid by Social Security. He described how these
retirement assets must be distributed under the minimum required
distribution rules. Most current retirees roll over their lump-sum
distributions of any size to IRA and are exceedingly (even to a
fault) conservative in their spend down of retirement assets.
Mr. Wray commented on the tax considerations of distributions
from DC plans and how they impact the participants’ after tax
income. He described options for limiting tax implications by
creative distributions of amounts in tax deferred accounts.
He noted the innovation that is occurring in the DC industry,
citing an example (Income Solutions) which is different from those
offered by earlier witnesses. He listed the benefit of this
approach to underscore the necessity of refraining from excessive
regulation as a way to encourage additional innovation. He
suggested several considerations looking forward, including
defining the employer’s role in helping former employees, noting
smaller employer concerns to avoid future fiduciary responsibility
for separated employees (essentially the traditional approach).
Yet, larger employers tend to encourage participants to leave
their assets in the plan to take advantage of economies of scale
to reduce costs and maximize performance. Employers appear to be
encouraging employees, who are looking for income stream
distributions, to consider annuity products provided by vendors
with whom they already have relationships.
Mr. Wray discussed the extent some companies are involved in
financial counseling (using a “holistic” approach) to help
employees understand future financial obligations and options,
noting direct correlations between such practices and company
size. He reiterated his concern about excessive regulation since
there is still much unknown about retiree behavior over periods
immediately after retirement as well as how behavior may change
over time. It is difficult to predict the needs of younger
employees over the long-run, and he observed that the behavior of
participants who take a lump sum, including whether and when they
decide that annuitization makes sense for them.
He suggested it may be time to re-evaluate the gender-based
longevity differences, especially for married women, to find
appropriate individual solutions. The current rules governing
annuity distributions within plans (requiring the use of unisex
tables) tend to act against the best interests of men. Similarly,
long-term care is clearly more appropriate for women as a planning
device, as the likelihood of women to need such care is far
greater than that for men.
In conclusion, Mr. Wray emphasized what he believes is the
potential for evolutionary change in the area of DC plans urging
restraint in placing any new restrictions on the way DC plans will
function in the future.
Dallas Salisbury, Employee Benefit Research Institute
As President and CEO of the Employee Benefit Research
Institute, Dallas Salisbury began his testimony by explaining that
money purchase plans, which provide an annuity option as a
mandatory component of the plan design, number fewer than 35,000
and cover fewer than 3 million participants. By contrast, there
are more than 600,000 other types of defined contribution plans
with over 48 million participants, and those are not required to
provide an annuity option.
This move away from Money Purchase Plans is indicative of a few
trends that will impact retirement financial adequacy over the
life span of all Americans: 1) Plan sponsors have no burning
desire to offer life income annuity options; 2) Participant
interest is low in such options -- less than 5%; and 3) Movement
from employer-funded retirement plans to those that rely on the
worker as the primary funding source.
Over recent decades, research documented the lack of interest
in life income annuity products. Yet, actual participant behavior,
which is monitored by plan sponsors, is more important.
There is a regular flow of sponsors shifting from traditional
defined benefit plans to either hybrid plans or defined
contribution plans which offer participants a single sum
distribution option. As they move from a defined benefit plan into
retirement, workers have opted out of low cost annuities with
excellent survivor features and PBGC guarantees. Even with the
above, between 66 percent and 99 percent opt for single sum
distributions.
Based on these facts and patterns, it will be difficult to move
large numbers of participants into choosing income annuities as
they leave defined contributions plans for retirement. Still, some
participants will find these options attractive. Since the QDIA
regulations did not embrace stable value products, such annuity
defaults may be the easiest way for participants to place dollars
in the low risk option, while retaining the option for single sum
distributions.
Mr. Salisbury directly answered questions which the Working
Group posed to witnesses, as follows:
What type of income streams should be available, and what
are the advantages and disadvantages to participants?
Mr. Salisbury replied that individuals overvalue single sums,
underestimate longevity, and overestimate how much they can
withdraw each year and not run out of money. Some engage in
hoarding behavior for fear of running out of money or desire to
leave money to survivors. For most Americans, the ideal would be a
product producing a steady stream of payments which rise with
inflation and last a lifetime. Most current products leave this
burden on the individual.
How do current practices in plan distribution design
support retirees abilities to manage income through retirement?
How could they be enhanced?
Mr. Salisbury replied that fewer than 20 percent of defined
contribution plans offer an income annuity option. All
participants have the ability to purchase such annuity products
outside the plan. Unfortunately, those products suffer from a
retail issue. Some sponsors desire to offer more of these products
as they become available. Concerns related to fees and regulatory
burden have further negative impact on such products.
What are the current obstacles to offering income options
vs. lump sums? Why do participants select lump sum options more
prevalently than periodic income options? How can these obstacles
be overcome?
Mr. Salisbury replied that the issue is fiduciary in nature.
Income annuities are not desired by participants and other income
options provide no assurance of funds lasting as long as the
individual. It is clear that participants do not understand life
income/lump sum math. They desire control of the distribution –
desire leaving something to survivors and want tight control in
the event of emergency.
What are the barriers to offering a default periodic
distribution option to participants who either leave balances in
the plan or who roll account balances out of plans? How can these
be overcome?
Mr. Salisbury replied that the barriers are the law for an
annuity default and fiduciary liability for choosing the default
provider if a life income annuity, or the payment amount if it is
just a stream of payments. It was the opinion of Mr. Salisbury
that the liability could not be overcome.
What data is available or that can be shared regarding
how participants utilize account balances at retirement? What are
the key findings?
Mr. Salisbury replied that the Census Bureau, the Fed and the
Retirement Confidence survey are consistent regarding what
participants do with their money when they leave a plan. A small
amount choose annuity, while most either leave it in the plan or
rollover to an IRA.
What is the best manner to provide participants with
education about distribution options and the importance of these
choices?
Mr. Salisbury opined that the best method includes planning and
one-on-one education. No other method will actually produce enough
information to overcome issues noted by those in “behavioral
finance“ and the numerous studies identifying the challenges
related to this question.
Mr. Salisbury commented that few plans offered today are more
than tax deferred savings plans. They are not retirement plans
alone. His rationale related to the fact that single sum
distributions from job changes provides access to these funds
throughout life.
Robert J. Doyle, Employee Benefits Security Administration
Robert J. Doyle, Director of Regulations and Interpretations
for the Employee Benefits Security Administration, U.S. Department
of Labor, reviewed the fiduciary principles relevant to the
Council’s consideration of the issues related to the spend down
of defined contribution assets of retirement, often referred to as
the “decumulation” phase.
While much attention has been devoted to assisting defined
contribution plan participants increase retirement savings, called
the “accumulation” phase, Mr. Doyle noted the recent focus on
post-employment retirement issues. With this in mind, he said it
is important to evaluate the approaches, from a fiduciary
standpoint, that can assist a worker in determining an appropriate
income level upon retirement.
Mr. Doyle referred to a recent study, prepared for the
Americans for Secure Retirement by Ernst & Young, that
concluded almost 3 out of 5 new middle class retirees will outlive
their financial assets if they attempt to maintain their
pre-retirement standard of living. He commented, “whether and to
what extent ERISA’s fiduciary principles apply will depend on
how employers decide to assist their employees in addressing
distribution and post-employment money management issues.”
Employers have two options, The first is “the distribution
alternatives available to participants and beneficiaries under the
plan.” The second is the availability of education materials and
financial planning services to assist plan participants and
beneficiaries in understanding their distribution options of
post-employment money management issues.
Concerning the distribution options, the determination by an
employer to include such an option or options in the plan is a
matter of plan design. It is a “settlor” activity that does
not implicate ERISA’s fiduciary responsibility rules.
Implementation of such provisions, however, constitute fiduciary
acts governed by ERISA and must be undertaken “prudently and
solely in the interest of the plan’s participants and
beneficiaries.”
Implementation of such options will involve the selection and
monitoring of service providers and contracts and/or investment
alternatives. This process must be undertaken objectively,
allowing plan fiduciaries to assess the provider’s
qualifications, quality of services offered, and reasonableness of
fees charged for the service. It must avoid self-dealing,
conflicts of interests or other improper influence (Field
Assistance Bulletin 2007-1). Specific fiduciary considerations
will depend on the particular nature of services and the product
under consideration. Mr. Doyle noted that annuities are offered as
a distribution option.
To assist plan fiduciaries in discharging their ERISA
responsibilities when selecting annuity providers and contracts,
Mr. Doyle stated that DOL had published a proposed safe harbor in
September 2007. This safe harbor set forth steps that fiduciaries
could take and to have satisfied their duties to act prudently and
solely in the interest of the plan’s participants and
beneficiaries. Mr. Doyle’s office is currently working on the
final regulation, and he hopes “that the clarity and simplicity
of the final ‘safe harbor’ will encourage more employers to
consider annuity options, or investment options with annuity
features, in their defined contribution plans.”
Mr. Doyle emphasized the provision of education and information
about distribution options and financial considerations may assist
plan participants in appreciating the importance of any such
distribution arrangement. He said the mere fact that education
advice might take into account financial resources outside the
plan, would not, itself, limit the plan’s ability to treat
expenses for such services as reasonable expenses of the plan for
purposes of various sections of ERISA, 403(c), 404(a)(1)(A) and
408(b)(2). But if the advice and recommendations focus primarily
on the participants’ non-plan financial resources, it is Mr.
Doyle’s view that the expenses attendant to such advice may not
be reasonable plan expenses.
In the course of his presentation, a point of emphasis by Mr.
Doyle was that employers should understand that if a presentation
to its workers involves a discussion of investment options under
the plan, rather than general financial planning or educational
information and materials, the employees may well view the
presentation or seminar as being endorsed by the employer, with
consequent legal implications.
Jeffrey Fishman, JSF Financial, LLC
As President of JSF Financial, LLC, Jeffrey Fishman is a
fee-based advisor who specializes in personal financial and tax
planning.
Mr. Fishman began noting statistics that indicate significant
debt burdens for many retirees as well as a common preference for
lump sum distributions from qualified retirement plans over
annuity options. He gave numerous reasons why these situations
currently exist and believed a big key for American workers is to
minimize or eliminate their debt at or before retirement.
In an effort to ensure larger amounts of guaranteed retirement
income, Mr. Fishman thinks it would be highly beneficial to offer
participants a variety of distribution or annuitization options in
addition to the lump sum method.
Mr. Fishman proposed three options regarding immediate
annuitization: 1) fixed immediate; 2) inflation-adjusted fixed
immediate; and 3) variable immediate annuities. All three options
should offer single life, joint and survivor, life with period
certain, and period certain distribution modes. Another possible
attractive option is hybrid alternatives, whereby participants are
allowed to take a partial lump sum distribution and combine it
with an annuity type option.
Mutual fund families have introduced funds to help provide
income streams for plan participants whereby the fund companies
make the asset allocation choices and decisions about how best to
meet systematic withdrawals. Such funds do not provide guaranteed
income.
Education is vital to helping people make the best possible
decisions. Mr. Fishman recommends participants should be mandated
to integrate their “real-life” situation into some form of
capital needs analysis. While no one can accurately predict the
future, this approach would lead to more informed decision making.
Employers should be given incentives to provide education to their
employees in order for them to make informed plan distribution
decisions.
Financial advisors should be seen as educators and guides for
plan participants. Advisors should be encouraged to work with
participants on a one-on-one basis without fear of being
susceptible to liability due to general investment volatility.
Computer models and programs cannot take into account all the
subjective concerns that a financial advisor can consider in
offering one-on-one personalized services to participants.
Expanding the number of distribution options is a good idea,
but recall that simple methods often are most effective. Any
innovation in plan distribution options needs to take this concept
into consideration.
Jody Strakosch, MetLife Institutional Income Annuities
Jody Strakosch, National Director for MetLife’s Institutional
Income Annuities, began the panel introducing the guaranteed
income products that MetLife introduced in the past few years.
Demographics and the shifting retirement landscape create
challenges, which raise policy concerns.
Most participants take a lump sum distribution and do not use
it wisely. Education is a critical element and should continue
past retirement. Tools, education, and periodic reports that help
participants determine target levels of income would be helpful.
Participants need access to financial advisors. MetLife suggests
educational brochures on decumulation would be useful. Retirees
underestimate their retirement financial needs and underestimate
their life expectancy.
Annuities can be helpful as both an accumulation and
distribution option. All annuities have a minimum $100,000 State
Guarantee Insurance Association coverage. To respond to potential
loss of control issues, the insurance industry has responded with
flexible features.
Few employers offer annuities due to administrative
difficulties and fiduciary concerns. The DOL should clarify plan
sponsors’ fiduciary obligations when selecting annuities. Plan
sponsors should adopt retirement income policy statements and also
provide participants with conversion estimates.
In conclusion, the DOL should simplify regulations: provide a
safe harbor for annuities and simplify the Qualified Joint and
Survivor Annuity (QJSA) notice and disclosure requirement. Defined
contribution plans should provide a lifetime income option.
Fred Conley, Genworth Financial
President of Institutional Retirement Group for Genworth
Financial, Fred Conley testified that employees bear the burden of
saving, but 401(k) plans were originally meant to be supplemental
to defined benefit plans. Now they are primary, and thus are being
restructured.
Mr. Conley discussed Genworth products and why employees should
buy them. The 401(k) annuity investment options that combine an
account balance with a retirement income focus allow participants
to maintain a balanced portfolio with equity exposure up to and
through retirement, with a guaranteed floor of income that
provides protection against longevity risk and down side market
volatility. Participants make contributions into the group
variable annuity as they would any other investment option –
through payroll deduction or transfers of existing balances.
Unlike most options, however, each contribution into the annuity
contract has a specific amount of guaranteed retirement income
that participants will receive for the rest of their lives. They
know the guaranteed income amount ahead of time, which helps them
have more control over their retirement planning. Participants can
transfer money into and out of the annuity at any time prior to
retirement without penalties, and participants have access to
emergency cash post-retirement. Rather than asking participants to
self-insure longevity risk through their own investment and
withdrawal decisions, Genworth assumes a longevity risk and
provides an income guarantee regardless of the performance of the
underlying portfolio. This is only one example.
Another example given was the option to use a guaranteed income
product as a QDIA within a 401(k) plan. Including a guaranteed
income product as a QDIA would improve lifetime financial incomes
for participants in 401(k) plans. Mr. Conley noted plan sponsors
demand lifetime income options.
Clarification of the financial standards that apply to the
selection of an annuity contract in defined contribution plans
could facilitate the use of annuities and increase the level of
annuitizations in these plans. In the Pension Protection Act (PPA),
Congress asked the Department of Labor to clarify that IB 95-1
does not apply to individual account plans, and thus participants
can buy annuities in their individual accounts. The proposed
annuity regulations, he said, are too complex.
Mark Foley, Prudential Retirement
Prudential Retirement’s Vice President Mark Foley said that
decumulation is the most important policy issue we have today.
Prudential offers various products to address this issue,
including traditional and alternative life time income solutions.
Market place solutions are the key to fixing this problem. One
important product is the Prudential Income Flex, which Mr. Foley
wished the Council to understand.
Since the level of annuitization is abysmally small, Prudential
helps sponsors design plans to provide lifetime income. The
solution – called guaranteed minimum withdrawal benefits – is
attractive because it “take[s] characteristics that individuals
like about an annuitization, the security of guaranteed income,
the certainty of withdrawal amounts, and repackage[s] those into
an offering that addresses those behavioral concerns, that gives
them … the flexibility to control the transparency, as well as
retains them within the investment framework that most individuals
view their 401(k) plan.”
According to Mr. Foley, we need to complete what PPA started.
We have automated enrollment, automated contribution escalation,
we have automated default investing. Now we need income solutions.”
The Qualified Default Investment Alternatives (QDIA)
regulations made it clear that including a guarantee did not
invalidate the QDIA. They did not, however, clarify how that can
be incorporated, what standards need to be evaluated, and what
testing needs to be met in order to ensure prudence in that
election. The guidance should be broadened to take into account
innovation and new ideas around the nature of providing
guarantees.
Sara Holden, Investment Company Institute
Sara Holden, Senior Director of Retirement and Investor
Research at the Investment Company Institute (ICI), began the
panel’s testimony by providing a summary of ICI statistics. She
presented research on how participants invested in retirement
accounts at ICI member firms to utilize their account balances at
retirement. ICI research confirms that while 57% of defined
contribution plan retirees take a lump sum distribution of some
(or all) of the balance, 86% of those lump sum distribution
recipients reinvested some (or all) of the proceeds, with the
majority moving their money to IRAs.
ICI research shows retirees have vastly different needs for
their retirement assets which depend on a wide variety of factors,
such as age, health, and other sources of income at retirement.
There is no universally accepted, or generally applicable, way of
spending down retirement assets. That said, ICI research supported
the conclusion that most retirees are clear about why they make
their choices at the time of a retirement distribution decision.
Lastly, in response to these varied retiree income needs, Ms.
Holden noted ICI has seen significant recent product and
distribution payout option innovation.
Ms. Holden summarized ICI’s recommendations as follows:
-
The Department of Labor (DOL) should adopt regulatory
policies to facilitate greater use of advice and educational
programs. The DOL Interpretive Bulletin 96-1 should be extended as
necessary to cover education for the spend-down phase;
-
The DOL should complete its work on the Pension Protection
Act’s investment advice rules; and
-
The DOL should develop additional educational materials to
help participants with distribution decisions at retirement and
make these materials easily accessible on the Internet.
Ann Combs, Vanguard Investments
Ann Combs, Principal in charge of Vanguard’s Institutional
Strategic Consulting Group, next testified that it is clear that
innovative solutions are developing to assist DC participants with
their retirement needs. Some solutions emphasize control,
flexibility, and low costs, along with exposure to the capital
markets. Other solutions emphasize guaranteed income for life,
although typically with higher fees and less liquidity.
Ms. Combs stressed that the public policy goal should not favor
certain solutions over others. Rather, public policy should foster
approaches that allow plan sponsors to make informed choices on
behalf of their participants, in turn enabling participants to
make choices among those options.
While traditional annuities are a valuable tool for managing
longevity risk, Vanguard believes that many plan participants will
choose not to annuitize most of their assets for important
reasons. One reason is that many households, especially low-income
households, receive a substantial level of replacement income
through Social Security. While some prefer predictable incomes for
regular living expenses, many households are concerned about
maintaining liquidity and control to tap savings for unexpected
costs like heath care.
For many of these reasons, there are significant innovations in
devising products that convert asset balances into income streams.
Vanguard has recently introduced managed payout funds designed for
investors who have dual goals of investing assets during
retirement and taking some measured risk with their savings while
also seeking some regular payments from that pool of assets. With
these payout funds, Ms. Combs noted that the fund manager assumes
the uncertain and time-consuming responsibility of determining and
implementing an effective retiree spend-down strategy.
Vanguard’s research shows that participants are much more
active decision makers at retirement than during their
accumulation phase. Research indicates retirees are willing to
work actively to overcome the federally-mandated joint and
survivor annuity default rules that currently exist for defined
benefit plans.
Ms. Combs opined that current fiduciary rules for selecting and
monitoring investment and insurance products do not require
significant revision. In her view, the current general fiduciary
rules are sufficient as they require plan fiduciaries to consider
the risk, return, the cost, as well as the credit quality,
solvency, and nature of an annuity contract.
Lastly, Ms. Combs urged the DOL to clarify the guidance offered
under Interpretive Bulletin 96-1. Interpretive Bulletin 96-1
confirms plan sponsors can give general investment education
without taking on fiduciary responsibility, which should also
apply at the time of spend-down. Essentially, many plan sponsors
would like to educate their participants – or allow a service
provider to educate their participants – about annuity, payout,
and other income options that are available outside the plan,
without fear of taking on ERISA fiduciary liability.
Douglas Kant, Fidelity Investments
Douglas Kant, Senior Vice President and Deputy General Counsel
for Fidelity’s Institutional Retirement business, confirmed his
firm’s experience that only a small number of defined
contribution plans offer the life annuity option. This is partly
for fiduciary concerns and partly because participants simply do
not select the option even when available. Most retirees
withdrawal their 401(k) plan funds in a lump sum, partly because
they are unsure what to do with their retirement income. In that
regard, Mr. Kant reiterated Ms. Combs’s call to confirm that DOL
Interpretive Bulletin 96-1 be modified to confirm that, at the
spend-down phase, employers may provide education assistance.
Mr. Kant explained that participant disclosure is an important
area of focus. It would be helpful to participants, plan sponsors
and service providers if the DOL provided guidance on what would
be necessary and useful disclosure to participants.
Annuities differ significantly in terms of product design. Some
products are designed to be liquid while others are semi-liquid.
It would be helpful to have guidance under ERISA section 404(c)
addressing the issue of restricted annuity liquidity measured
against the level of expected investment volatility, as
contemplated under existing ERISA section 404(c) regulations.
Mr. Kant commented that his firm has an insurance company and
an insurance agency. Notwithstanding the lack of insurance product
activity in 401(k) plans, his firm does have significant IRA
insurance product activity. In his firm’s experience,
individuals who roll over their money to an IRA from their 401(k)
plan, and who buy an annuity with some of that money, tend to wait
an average of three years before making the annuity purchase in
their IRA. Mr. Kant confirmed this delay indicates individuals are
thoughtful about the annuity-purchase process.
Mr. Kant described his firm’s income replacement fund, which
allows the investor to pick a future date and to receive an income
stream that culminates in that year. This design allows the
fund-manager to bear the responsibility for managing the
investment mix during the pay down rather that the participant.
Answering a question, the panel confirmed their income products
are not intended to be “one-size-fits-all” products. Rather,
these products serve as part of a package of planning.
Responding to another question, Ms. Combs reaffirmed her call
for a level playing field for defined contribution annuities as
special rules or tax breaks that incent individuals to invest in
one product type over another should not exist. Mr. Kant responded
that changing to an annuity default in defined contribution plans
may not make sense, because retirees appear as fairly active as
decision makers and may opt out of the annuity completely.
Mr. Kant again confirmed, in answering another question, the
DOL would help the field by clarifying the boundaries for
employers discussing rollover and other retiree options, without
concerns over ERISA fiduciary risk. Mr. Kant reiterated that plan
sponsors would like to permit service providers to educate
participants about their outside-of-the-plan-options without
taking on fiduciary responsibility.
In response to a final question about the level of
proliferation of payout-oriented funds in the mutual fund
industry, Ms. Holden confirmed that target date funds have been
popular on the accumulation side since the early 1990s. On the
decumulation side, Ms. Holden noted that there are some firms,
including Fidelity and Vanguard, offering innovations in payout
funds. For years, there have been fixed-income or balanced funds
that generate income and many of the target date sweeps include a
retirement income fund that can either be converted to or
exchanged to at retirement.
Neil Lloyd, Mercer Investment Consulting
As Principal of Mercer Investment Consulting and a UK-certified
actuary located in Vancouver, Canada, Neil Lloyd is also the “intellectual
capital leader” for Mercer’s Global Defined Contribution
business. In his testimony, he compared international practices to
US examples, acknowledging that no country has completely mastered
decumulation. His international experience leads him to conclude:
-
Most retirees have retirement assets spread across many
plans because of job changes. This makes plan-based solutions
problematical. The industry and regulators should promote
consolidation - transfers into the participants’ new plans. If
not, plan-based solutions are limited;
-
Generic advice or generalizations are more reasonable in the
accumulation phase than the spend-down phase. Auto-default
spend-down options can be suboptimal because they rely on
generalizations about people;
-
The benefits of annuitization need to be better explained,
but not oversold. Diversification of products in the spend-down
phase will generally be preferred over a single strategy. Although
not always the case, commonly 60% of the amount a retirees
receives comes from investment returns in the spend-down phase.
Some assets may be in annuities, others in drawdown, while some
remain in mutual funds. This flexibility can help address varying
circumstances as well as the issue of confidence (not all eggs in
one basket);
-
The decision to include a combination
accumulation/spend-down product into a plan lineup should consider
when the product would become attractive. The case for annuities
is far stronger after retirement than before, so the deferred
annuity option should not be oversold before retirement; and
-
The financial planning community should develop tailored
retirement investment and spend-down strategies. Where sponsors
are prepared to provide such assistance, they should be encouraged
(and protected).
An optimal spend-down strategy considers a retiree’s: 1)
needs vs. wants; 2) risk tolerance; 3) all resources; 4) need for
simplicity; 5) wishes for bequests; and 6) longevity. Most
retirees and planners underestimate life expectancy. Retirees may
select the easier to understand option, even if it is inferior.
Avoid the “misery of choice.” Much industry analysis focuses
on the roles specific products play while very little analysis
looks for an optimal combination of products. Hence, analysis
tends to suggest a larger product variety, even “when if looked
at holistically” a product may not be part of the optimal
combination.
Ideally, participants near retirement should tailor investment
strategies to likely spend-down patterns. Here are ways to
encourage this pre-retirement:
-
Provide income projections on statements from pension plans
and rollover accounts (although the basis of projections can be a
problem).
-
Encourage participants to consult financial planners on and
avoid discouraging employers from offering such services; and
-
Encourage near-retirement seminars where participants
consider how they will manage in retirement - emphasizing the need
for the member to develop a holistic strategy that covers all
their retirement assets.
Anna Rappaport, Anna Rappaport Consulting
Anna Rappaport formed Anna Rappaport Consulting after retiring
as a Worldwide Partner with Mercer Consulting. A former President
of the Society of Actuaries, Ms. Rappaport currently chairs its
Committee on Post Retirement Needs and Risks. She has been heavily
involved in the education efforts of the Actuarial Foundation and
currently serves as a Senior Fellow on Pensions and Retirement for
the Conference Board.
In her opening comments, Ms. Rappaport explained her “dream
distribution options” for a 401(k) plan. The fundamental drivers
of this “dream” are 1) giving the participant enough time to
think through irrevocable decisions, 2) allowing the participant
to annuitize over time, 3) allowing additional withdrawals during
the period where a longer term plan is put in place, 4) assuring
an individual considers the choice of an annuity, 5) providing the
opportunity of dollar cost averaging, and 6) viewing the decision
from a holistic portfolio point of view. Since many Americans use
short-term thinking in their planning, better planning is needed
to maintain income in retirement. A stand alone 401(k) plan is
fundamentally different than a DB plan with a supplemental 401(k)
plan.
There are obstacles to life income options. Lump sum payments
are common practice, even though participants say they want
lifetime income. Their decisions appear to be intuitive. Education
is needed on the income stream and the trade-offs associated with
the decision. There are also complex regulations to understand as
well as the differences to be considered between men and women.
Innovations in financial products continue in the market place
presenting challenges for comparison and basic understanding of
products and options.
Ms. Rappaport’s short term specific recommendation for the
DOL was to develop education to help people better understand the
trade offs in their decision making process. Education is needed
on guaranteed income, costs and fees, longevity risk, Social
Security, irrevocable decisions and liquidity needs. Participants
need to understand this is the money they will live on for the
rest of their lives. Key questions that need to be raised include:
1) How much of the portfolio should be annuitized? 2) How should
spouses be protected? 3) How does this fit into the total
portfolio? 4) Should income be guaranteed? 5) Is the decision
irrevocable? 6) How do the minimum distribution rules come into
play? 7) What kind of trade-offs are there? 8) When should Social
Security be claimed?
Ms. Rappaport outlined the barriers to a plan sponsor offering
a default periodic distribution as: 1) participant expectations -
as a society we do not think of the balances as related to
retirement income; 2) many income options are irrevocable; 3) a
tendency to use the entire balance in the same way, and 4) the
plan sponsor is subject to increased fiduciary risk and complex
administrative tasks in order to offer annuity benefits or
alternative arrangements.
Phil Suess, Mercer
As Worldwide Partner with Mercer Investment Consulting, a
registered investment adviser, Phil Suess is the segment leader of
Mercer’s defined contribution business. With 30 years experience
in the investment of retirement plan assets, he testified about
the DC marketplace for the spend-down phase, including new
distribution alternatives, barriers to new products and possible
steps to help participants and sponsors make better decisions for
retirement security.
Participants confront issues in decumulation akin to
accumulation. Participant success in the spend-down phase is
highly dependent upon prior success in the accumulation phase.
Yet, the vast majority of DC plan participants do not know: 1) the
amount of assets they will need in retirement; 2) the amount of
contributions necessary to accumulate sufficient assets; 3) the
earnings needed on their contributions; and 4) how to invest their
assets to have a reasonable probability of adequate earnings. In
the spend-down phase, participants: 1) fail to grasp longevity
risk; 2) remain disinterested in investments; and 3) prefer to
delegate decision-making to third parties. Experience shows the
success of educating participants to make informed decisions has
been disappointing at best.
Over the past several years, the insurance and money management
industries have introduced retirement income products. Money
managers focus on asset allocation, liquidity and control while
the insurance industry emphasizes assumption of risk and
guarantees. Increasingly, age-based lifecycle products are based
on a participant's anticipated life expectancy rather than
anticipated retirement date. The mutual fund industry offers
distribution products to provide ongoing income over a specified
number of years while the insurance industry increasingly offers
guaranteed products at lower cost combined with increased
liquidity, relative to prior products. The incorporation of
annuities within a broad asset allocation, and the establishment
of minimum guarantees within asset allocation products may be
desirable since the guarantees are embedded within the products
and do not require separate plan sponsor and participant election
decisions.
The challenge to plan sponsors and to participants is to
evaluate the benefits of the products, which incorporate the
features of both industries. Despite innovations, sponsors and
participant maintain basic objections to distribution products.
Plan sponsors are concerned in offering products to participants
who are no longer active employees. They worry about fiduciary
liability in offering guaranteed products in their plans.
Participants fear being unable to access their assets if needed.
In response, newer products provide some level of guarantee and
participant access to their money (at the expense of reducing or
eliminating the underlying guarantee).
Mr. Suess concluded:
-
The DC plan community should readily accept annuities as a
distribution option.
-
DOL should remove barriers and provide guidance that will
increase the utilization of investment products that promote
enhanced retirement security.
-
DOL/Congress should make ERISA Section 403(a) protections
contingent upon sponsors' offering, but not mandating, a
guaranteed income distribution option.
-
DOL should provide guidance that addresses a sponsor's
fiduciary concerns in offering annuity products in DC plans.
-
There should be a Pension Protection Act II that encourages
default options that emphasize distributions over retirement and
investment advice products that address longevity risk, including
the anticipated income that assets may provide over a lifetime.
-
Encourage participants to keep assets within DC plans after
retirement. The quality and costs of the investment products
within a qualified plan are superior to those found on a retail
basis.
Jason K. Chepenik, CFP, AIF, Managing Partner, Chepenik
Financial, an NRP Member Firm
Mr. Chepenik’s comments focused on the relationship between
the investment advisor and his individual and corporate clients
and the way consultants can best help prospective retirees
anticipate and plan for what they will face when they stop
working.
The role of the investment advisor must be not only to make
recommendations but also to educate plan sponsors about fiduciary
responsibility, understanding revenue sharing, legislative changes
and the nature of relationships, and, moreover, what defines a
successful retirement plan. Plan sponsors who lack knowledge do
not know the risk they are exposing themselves to.
The products consultants sell or recommend are typically the
same, and are not necessarily designed to enhance the employee
experience or financial security. The vast and ever changing array
of products begs the question of whether the products are really
better for employees or merely a vehicle for maintaining a steady
stream of income for product manufacturers, vendors, and plan
advisors. The distinguishing factor among consultants is the
creativity and knowledge of the person providing the advice. Many
retirees are faced with managing a large sum of money far in
excess of their former incomes, without a clear understanding of
how to make it last through retirement. Bad decision making often
results from this lack of understanding. Current gap analytics
tend to use assumptions that are no longer based in reality,
estimating living expenses at 70-85% of pre-retirement, and
inflation at 3-4%. In reality, higher costs faced by retirees,
particularly in the area of health costs, tend to skew both
numbers significantly higher.
Costs of products are difficult to understand. Portability
allows flexibility but at higher cost and greater risk. Systematic
withdrawal from investment accounts is a common recommendation,
but is not always easy to achieve under current plan designs. The
concept of “guarantee” is used in many contexts, sometimes
inappropriately. The confusion over this term leads to
misunderstanding and frustration on the part of plan sponsors and
participants.
Mr. Chepenik’s recommends better educating sponsors and
participants with statements that clearly show “assumed monthly
income” on contribution statements, increasing penalties for
early withdrawals to encourage savings, and providing tax
incentives to participants who select systematic withdrawal
options. In addition, participants should be able to choose from a
variety of annuity payouts. Plans that utilize economies of scale
to purchase institutional annuity contracts will provide a lower
cost option to participants.
The DOL should consider requiring gap analytics that are true
and accurate with more realistic assumptions. Mr. Chepenik
recommends using 100% of pre-retirement income with 5% or more
inflation as better metrics. This would allow greater cushion for
unanticipated expenses in retirement. The DOL should also consider
qualifying how firms can use the word “guarantee” in this
particular segment of the marketplace.
Steven Saxon and Louis Mazawey, Groom Law Group
Steven Saxon and Louis Mazawey, members of the Groom Law Group,
testified regarding the legal obstacles and barriers that need to
be addressed in connection with the offering of guaranteed
lifetime income and annuity distribution options under defined
contribution plans. Mr. Saxon testified that his clients ask the
following questions when considering whether to offer an annuity:
-
Am I a fiduciary in connection with this decision?
-
If so, is there a way to avoid it?
-
If not, what are the risks of failing to meet my
responsibilities and how can I minimize these risks?
-
What are the costs associated with these actions?
According to Mr. Saxon, if the risks are too great, plan
sponsors will not offer annuities, especially since these options
are available outside the plan. Mr. Saxon provided the following
guidance with regard to the questions posed above.
The decision to provide an annuity distribution option is a
plan design decision and, therefore, is a non-fiduciary settlor
decision. The implementation of this decision is a fiduciary act
and a plan sponsor would be acting as a fiduciary in connection
with the selection and ongoing monitoring of an annuity provider.
The DOL has proposed regulations under Section 625 of the Pension
Protection Act (the “PPA”) which directed the Department of
Labor to issue regulations that clarified that the selection of an
annuity contract as an optional form of distribution from a
defined contribution plan is not subject to the “safest
available annuity” standard contained in DOL Interpretive
Bulletin 95-1. The proposed regulation provides a procedural safe
harbor but contains many requirements and considerations that are
applicable to the selection of annuities that do not apply to
other plan investment choices. These requirements discourage plan
sponsors from offering annuities and despite the intent of Section
625 of the PPA, the proposed regulation makes no significant
changes that would result in greater utilization of annuities. For
example, the proposed regulation would impose 14 separate
conditions for fiduciaries to consider when selecting an annuity
provider. If any one of these is not satisfied, including the
hiring of an independent expert (when appropriate), a fiduciary
would lose the protection provided by the regulation. Mr. Saxon
suggested simplifying the regulation to require fiduciaries to act
prudently in the selection of annuity providers by eliminating
section (c)(2) and the need to hire independent experts that are
usually required only in cases where a conflict of interest is
present. It should also specify that a selection that does not
meet the regulation’s approach may nonetheless still be prudent.
Mr. Saxon offered other suggestions that would encourage plan
sponsors to offer annuities. These included a recommendation for
the DOL to issue a statement countering the negative impression
created by the Qualified Default Investment Alternative (QDIA)
regulations about the value of annuities, and other guaranteed
products such as guaranteed minimum withdrawal products, in
providing retirement security to participants. As well, Mr. Saxon
suggested that the DOL clarify that products which qualify as a
QDIA while a participant is active will continue to so qualify
when the participant is in pay status, so that a plan fiduciary
will receive the fiduciary protection of the QDIA regulation for
amounts that remain invested in the plan as a participant begins
spend-down of his or her account, so long as the other
requirements of the regulation are met.
Mr. Saxon also suggested that the Department should clarify and
extend Interpretive Bulletin 96-1 to permit plan fiduciaries to
provide participants with information on issues relating to the
decumulation stage of retirement, including estimates of the
amount of money needed and calculations of the best method to
ensure that retirement savings last throughout a participant’s
lifetime. Finally, Mr. Saxon testified that DOL needs to resolve
the issue of a fiduciary’s status when the fiduciary provides
assistance with respect to a distribution and a participant makes
a decision with respect to the investment of that distribution
outside of the plan.
Mr. Mazawey testified about the burdens to plan sponsors
resulting from the qualified joint and survivor annuity rules of
Internal Revenue Code Section 401(a)(11). Most defined
contribution plans are not required to offer annuity forms of
distribution. These compliance burdens arise only if a defined
contribution plan offers an annuity distribution option and a
participant expresses an interest in receiving an annuity. These
requirements do not apply to the election of lump sum
distributions or installment payouts. According to Mr. Mazawey,
many plan sponsors and fiduciaries believe that the administrative
burdens outweigh the benefits of offering an annuity option. He
encouraged the DOL to work with the Treasury Department to
streamline these requirements, simplify the procedures for
obtaining spousal consents and clarify that these rules do not
apply to guaranteed minimum withdrawal options.
Alison Borland – Hewitt Associates LLC
As Principal and leader of the Defined Contribution Consulting
Practice with Hewitt, Allison Borland co-authors many of Hewitt’s
surveys and studies, speaks on retirement issues and consults with
clients.
Ms. Borland began by her testimony by citing that fewer than
19% of Americans will meet 100% of their estimated needs in
retirement. She believes that this is because as more Americans
rely solely on a 401(k) plan for their employer-provided
retirement income, they are not equipped to effectively manage
income streams after retirement.
Ms. Borland’s testimony outlined four topics to be addressed
to facilitate a more thoughtful spend down of defined contribution
assets.
Current Payment Options and Participant
Elections. Currently
89% of participants take lump sums from 401(k) plans upon
retirement, while only 3% elect annuities. Ms. Borland suggested
that more flexibility related to periodic distributions and
increased participant education would help participants make more
informed distribution decisions.
Benefit of participants managing income from within a
401(k).
Hewitt research shows that almost one third of participants leave
their retirement savings in their employer’s 401(k) plan, 26%
roll their money to an IRA, and the remaining participants
withdraw it. Ms. Borland pointed out that participants need to be
educated about the benefits of keeping their assets in the
employer’s 401(k) plan. These benefits include: More effective
plan management, access to lower-cost, higher-value investment
options, and greater access to scaled purchasing power of
investment products and tools.
Regulatory and design changes needed. In order to make 401(k)
plans more attractive retirement income vehicles, Ms. Borland
suggested the following: Increase distribution flexibility, add
longevity insurance protection, allow post-termination loans,
facilitate account balance consolidation, eliminate barriers to
converting to a Roth 401(k), and elimination of “total
distribution” requirement for company stock distributions in
order to qualify for more favorable tax treatment.
Study distribution behavior in defined benefit
plans. When lump
sums are available, over 90% of participants elect lump sums over
annuities. Identify opportunities to improve retirement income
adequacy in these plans, too.
In conclusion, Ms. Borland stated that plan sponsors, providers
and the federal government can and should work together to explore
new and innovative ways to eliminate existing barriers and
encourage the use of 401(k) plans—and pension plans-- as
effective, long-term retirement income vehicles.
Joan Gucciardi, ASPPA
Ms. Gucciardi is an actuary with Summit Benefit & Actuarial
Services and she spoke on behalf of the American Society of
Pension Professionals & Actuaries (ASPPA).
Ms. Gucciardi noted two key categories to the spend down issue:
1) encouraging retirees to manage retirement funds wisely and 2)
encouraging pre-retirees to not spend retirement savings before
actually reaching retirement. Plan sponsors can facilitate this
process by design changes to their plans. Government can
facilitate this process through legislative changes to both ERISA
and the Tax Code.
She recommends encouraging plans to allow partial lump sums and
partial annuity options. Plans should offer participants the
opportunity to elect a portion of their benefits in a lump sum IRA
rollover and a portion as an annuity. She reasons that there is a
psychological desire to have a portion available as need for
unanticipated living expenses or for the initial expenses of the
transition to retirement.
Ms. Gucciardi recommends that annuity options be encouraged.
This would make the qualified joint and survivor annuity the
default option and require spousal consent for lump sums.
Electronic consent should be allowed under these arrangements.
Removing roadblocks to offering an annuity option in defined
contribution plans would help protect non-working spouses or
spouses that have non-continuous work history.
Another recommendation is to allow for advance IRA designation
for defined contribution plans. This idea would reduce leakage
from the system. Employees would be allowed to make a revocable
IRA designation at the time the employee enrolls in a defined
contribution plan and at the time the plan sponsor might move to a
new plan provider. This measure would also promote participants’
consolidation of their retirement assets in fewer accounts for
easier monitoring.
She also advocates permitting tax-free distributions to
participants from defined contribution plans if the proceeds are
used to purchase qualified long-term care insurance on behalf of
themselves, their spouse, their dependents, or qualifying
relatives (as defined in the Code). She sees long-term care as a
retirement savings protection mechanism. It is affordable and can
protect against the rapid deterioration of retirement savings and
the escalating costs of assisted living.
Ms. Gucciardi further recommends that small balances be exempt
from minimum required distribution calculations. The current rules
impose unnecessary administrative burden to both the plan sponsor
and the participant where small balances exist. She proposes an
exemption for any individual whose aggregate balance does not
exceed $50,000.
She recommends an amendment to 401(a)(9) to allow for purchase
of longevity insurance. This type of deferred annuity should be
allowed in qualified plans. Such annuities currently cannot be
purchased or used effectively inside qualified plans or IRAs
because of restrictions in the Code.
In order to minimize leakage, she proposes elimination of
active employee access to benefits at plan termination. She feels
the event of terminating a plan should not, in of itself, provide
access to qualified plan benefits for employees who have not
severed employment with the plan sponsor or met one of the plan’s
retirement age conditions.
Lastly, Ms. Gucciardi recommends that IRAs be allowed to accept
rollovers of 401(k) loan balances. Acceptance of loan balances and
periodic loan repayments will allow this money to remain in the
system. This would apply only to existing loans, not to new loans
within IRAs.
Jack Richie, Vice President, Human Resources, Rogers
Corporation
Mr. Richie appeared before the Council on behalf of the Rogers
Corporation, a manufacturing firm located in Rogers Connecticut.
He spoke from the perspective of a medium sized employer, with 900
employees in the U.S. Mr. Rogers described the process his firm
recently engaged in to re-evaluate their pension programs and
decided to cease eligibility in the firm’s defined benefit plan
for all of their employees except for their union represented
employees. In its place, Rogers implemented a comprehensive
defined contribution program for all employees, including union
represented employees (although no match would be provided for
that group).
Mr. Richie explained the process the firm went through to
understand what employees understood about the retirement savings
opportunities available to them and the impediments that employees
perceived that prevented them from participating in the program.
He explained that employee objections fell into three categories:
those who did not know how to invest the money; those who feared
losing the money; and those who do not know how to take the money
out after retirement. In response to these concerns, the company
conducted extensive educational sessions to help alleviate their
fears. When automatic enrollment became available, the company
enrolled all employees in the program at a three percent
contribution rate, with an escalation feature. He explained that
the efforts were very successful and expressed concern that
employers not be restricted from implementing comprehensive
retirement programs of the type his firm has adopted.
Mr. Richie responded to questions from Council members to
clarify certain terms referenced in his testimony and explained
that Rogers’ objective was to provide a fully comprehensive
program, including the educational component and a wide variety of
investment options. He also noted that one of the goals was to
make sure that the program and options were easy to understand.
Council member Helmreich asked whether their firm was aware of
the requirements that apply to employers regarding the design and
fiduciary protections of the Department of Labor’s regulations.
Mr. Richie noted that Rogers used outside consultants in the
implementation of the plan. He also responded to questions
regarding the “IncomeFlex” product implemented for older
employees (this non traditional life cycle fund with guaranteed
lifetime income features product is only available for
participants age 50 and older) including the take-up rate; how
they evaluated this product in selecting it; and what other
distribution options that are available to them.
Other Council members inquired as to the payment of
administrative fees for the program, which are all borne by the
participants; and the independence of the “independent”
advisors. He also responded to a question from Council member
Wiggins as to the firm’s experience with the requirements of the
Department of Labor regarding the adoption of the Income Flex
product and the choice of the vendors. Mr. Richie responded that
Rogers did not find the requirements overly burdensome (primarily
because it had outside help).
Council members Brambley and Koeppel asked and Mr. Richie
responded to questions about the process the firm would engage in
if the firm determined it was desirable to change vendors. He
explained that one of the basic tenants of the Company’s benefit
programs is choice, and he felt that any product they selected
would need to maintain the same level of choice provided by the
current program
J. Mark Iwry, Retirement Security Project
As Principal for the Retirement Security Project, Mr. J. Mark
Iwry summarized a recent Retirement Security Project paper that
offers options to replicate, within the 401(k), the attributes of
the defined benefit pension – lifetime income combined with
professional investment management. To encourage lifetime income,
a key element is to avoid the traditional all-or-nothing
annuitization choice. Lifetime income products can mitigate the
risk of outliving resources and permit a higher monthly payment
than nonannuity options. Despite the benefits, current retirees do
not use lifetime income products very much. Future retirees seem
unlikely to do so under current approaches. Iwry’s strategies
counter behavioral biases against annuities and encourage their
use.
Offer a "test drive" of a lifetime income
product. A
substantial portion of each account would default into a two-year
trial income product at distribution. The automatic trial income
arrangement would make 24 monthly payments, if the participant did
not opt out. At the end of the trial period, retirees could elect
an alternative. If retirees did nothing, they would default into a
permanent payment program. This could accustom individuals to the
security and simplicity of a “pension paycheck” over a lump
sum. It may become the presumptive form of benefit.
Reframe the choice. Plan sponsors should be required to present
benefits as an income stream of monthly or annual lifetime
payments, in addition to presenting the benefits as an account
balance in accordance with current practice.
Encourage lifetime income by gradually introducing it as a
default investment during the accumulation phase, including,
specifically, embedding it in the target maturity QDIA. Target
maturity, or life cycle default investments, are increasingly
prevalent in 401(k) plans and are generally well accepted by
employees as a means of achieving asset allocation and
diversification. Typically, these funds increase the percentage of
fixed income assets over an employee’s career. The fixed income
component might be comprised of annuity income units that grow
gradually. If plans chose to offer such funds, they would spread
the risk of interest rate fluctuations at the point of purchase
– a kind of “dollar cost averaging” – that allows a
portion of an account balance to be invested in deferred
annuities. Because annuity income units would accumulate
gradually, there is no single “moment of truth” at which one
irrevocably disposes an entire nest egg.
Encourage lifetime income by gradually introducing it via
employer matching. A portion of the incoming employer matching
contributions could be directed to the accumulation of deferred
annuity (mandatory or by default). New limits on investing
matching contributions in employer stock opens the door to
employer contributions in retirement security. Participants who
are skeptical about turning assets over to an insurance carrier
may invest “employer money” in annuity income. This can occur
gradually during accumulation and foster the notion that the “employer
matching” portion will provide lifetime income. This may
mitigate the interest rate risk by acquiring units over time.
Employer matching contributions often account for a third of an
account balance (or slightly less). To many employees, this might
be the right amount to devote to lifetime income. Both the QDIA
and the employer matching strategies could be structured to
complement the trial income strategy summarized earlier.
Longevity Insurance in Qualified Plans. Deferring the start of
an annuity until an advanced age such as 85 helps counteract the
“wealth illusion” that keeps some employees from converting
any of their account balance to periodic income. Many employees
are unpleasantly surprised to learn how “small” the monthly
payments are relative to a “large” account balance. This “sticker
shock” can be countered to some degree by showing employees that
they can purchase a meaningful amount of late-in-life longevity
insurance in exchange for a portion of their account balance. The
employee could retain the account balance to meet economic “shocks”
such as medical or long-term care needs. This approach protects
against the “tail” of the life span probability distribution
– the lower-probability risk that the participant will live to a
very advanced age. Facilitating “longevity insurance” will
necessitate addressing required minimum distribution rules under
the Internal Revenue Code.
Norman Stein, Pension Rights Center
As the Douglas Arant Professor of Law at the University of
Alabama, Norman Stein is spending this semester as a policy
consultant for the Pension Rights Center in Washington. His
testimony does not represent either affiliation, but represents
his own view on the important issues of “Spend Down.”
In his opinion, a very strong consensus exists among experts
that protecting retirees from longevity risk could provide
tremendous benefits. While it is not clear who benefits most from
protecting people from longevity risk, it is clear that retirees
are one group who would benefit. Mr. Stein suggested we have been
conditioned to emphasize conventional annuity products as a
solution to dealing with longevity risk. He established a list of
reasons why people don’t like annuities.
Individuals often prefer lump sum payments to annuities because
they fail to realize that they could outlive their life
expectancy. People tend to over-evaluate the spending power of
what will be, for many, the largest single sum of money they ever
receive. People usually are not given an alternative so they take
the money and roll it into an IRA instead of shopping or comparing
annuity rates and the associated benefit. Complexity of products
in the market simply overwhelms most people. They lack the
necessary education to consider all key issues related to annuity
products. Another major factor is the financial penalty of death.
Most people desire to leave a legacy for children/grandchildren.
There are also the dual concerns of company solvency for the
employer and the insurer if one was to select an annuity. For
employers, lump sums are “cleaner.”
By severing via lump sum, it is suggested that liability is
minimized in the future. Mr. Stein suggested that it is important
that retirement policy encourage pooling of longevity risks but he
cautioned that it may not be entirely clear whether this is
something that government policy should pursue. He went on to say
that perhaps government’s role should be to encourage a market
for annuities and similar products.
Mr. Stein wondered aloud it may not be appropriate to force
such behavior to change as a result of manipulation, incentives
etc. The first argument that could be raised against taking
specific actions would be the creation of the 401(k) itself. Mr.
Stein referred to the 401(k) plans as wealth-creation vehicles and
that each employee has to make several decisions based upon the
individual situation.
Perhaps no single answer is correct in this situation as
several have noted this wealth creation model is very attractive
compared to the traditional retirement plan and Social Security.
Mr. Stein’s position was that for those who believe this,
perhaps the best government action is to provide education about
annuities and help make an efficient market for annuities. Mr.
Stein quoted some well known facts regarding longevity to prove
the point that it could create wealth transference between various
groups, which he suggested may not be the best approach.
Mr. Stein discussed pre-retirement leakage and noted that it
was a greater concern. He went on to the subject of conflicts of
interest and felt, in summary, that it was better that people
selling and advising not be conflicted.
Inflation bonds came into the discussion as a possible goal.
Mr. Stein identified the benefits for both annuity providers and
the investment industry in seeing these as a way to structure
annuities. Mr. Stein thought the introduction of annuity, when
participants are young, made sense and should be considered. He
opined that it was premature to introduce a safe harbor as this
had not been experimented with in any way.
In closing, Mr. Stein suggested that he thought the following
ideas were worthy of consideration for the Council and or the DOL.
First, encourage employers to offer a default annuity as a viable
offering. Retirement bonds are a good idea as they serve multiple
purposes. He suggested defaulting some percentage into an annuity
product. He believed that we should offer a paternalistic view to
a degree. However, he stopped well short of actionable specifics.
*The Advisory Council's
report inadvertently omitted the summary of testimony by
Allison Klausner of Honeywell International, who testified on
behalf of the American Benefits Council. Anyone
interested in obtaining her written or oral statement may
contact the Council's executive secretary, Larry Good, at
201.693.8668.
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