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TOPICS IN
RETIREMENT INCOME
SIMPLICITY IS SOPHISTICATION WHEN CONTEMPLATING
RETIREMENT INCOME
The tides are shifting in the defined contribution (DC) plan arena. Plan sponsors are beginning to
recognize that a DC plan can – and must – play a more significant role in helping employees create
guaranteed lifetime income. With the growing realization that many workers will spend as much
time living off retirement assets as they spent accumulating them, DC plan sponsors have begun to
reframe the goals of their retirement programs beyond the notion of a savings-only vehicle.
MetLife’s 2016 Lifetime Income Poll found that a large majority of plan sponsors (85%) agree that
the core purpose of a DC plan should be to serve as an income source during retirement.1 This
represents a sea change from a 2012 MetLife study when only 9% of plan sponsors believed that
generating retirement income was their plan’s primary focus.2 In September 2016, the Government
Accountability Office (GAO) recommended to the Department of Labor (DOL) seven steps for
improving retirement income options for DC plan participants. These recommendations were based
on the agency’s survey of plan sponsors and a range of industry stakeholders. Yet, even before the
GAO released its report, plan sponsors had begun thinking about, or implementing, strategies for
recasting their DC plans from savings vehicles to income generators, according to MetLife’s survey.
For DC plans governed by the Employee Retirement Income Security Act of 1974 (ERISA), nearly
three-quarters of DC-only plan sponsors (70%) have already taken important preparatory steps for
the future addition of an income annuity.3
The core purpose of a DC plan should be to serve as an income source during
retirement, according to 85% of plan sponsors who responded to MetLife’s
2016 Lifetime Income Poll. In fact, one industry professional has suggested
that, “If the vehicle doesn’t have a lifetime income option, it doesn’t look like
a retirement plan.”4
In this paper we examine the various retirement income products available in the marketplace and,
importantly, how plan sponsors can decide which solution or combination of solutions is best suited
for their DC plan participants.
Guaranteed lifetime income has become an essential metric for accurately evaluating one’s true
“retirement readiness.” But the extent to which workers have access to guaranteed retirement
income solutions through a DC plan, either as an accumulation option during their working years
or as a distribution option at the point of retirement, or both, depends largely on the commitment
by DC plan sponsors to make these solutions available. DC plans that don’t allow participants to
convert all or a portion of their savings to guaranteed lifetime income are incomplete. Perhaps
that’s why most retiring employees opt to take their retirement savings as a lump sum. But
rationing their savings over three or more decades may be a bumpy ride for those who take the
lump sum or attempt to manage a drawdown strategy, as academic research shows that as many as
57% could run out of money in today’s economic climate.5
SIMPLICITY: THE ESSENTIAL ELEMENT IN STRUCTURING A RETIREMENT INCOME SOLUTION
When determining how best to design a retirement income solution for DC plan participants,
in words often attributed to Leonardo da Vinci, “Simplicity is the ultimate sophistication.” Plan
sponsors appear to agree with this thinking. A majority of plan sponsors (90%) believes that “it is
in the best interests of plan participants to keep plan design changes simple, since complexity, such
as too many choices and features, often leads to participant inertia.”6 For this reason, beginning
with a “back-to-basics” approach when considering retirement income plan design changes may be
the most constructive – and sophisticated – strategy for plan sponsors to employ.
Plan sponsors generally must decide whether to structure their retirement income approach as
an accumulation option alongside the plan’s investment options or as a distribution option at the
point of retirement. Sponsors will also want to determine whether to offer a fixed or variable
product. In order to select the option that is most appropriate for the plan, sponsors should take
into account the financial acumen of the participants, the ease by which the offering can be
communicated and the cost of the guarantees, among other considerations. Additionally, they
should adopt education tools that make the most sense for their participants.
By offering retirement income options as a component of – or a complement to – their DC plans,
employers are giving their retiring workers access to programs that are institutionally-priced, and
therefore, generally more competitive than those available in the retail annuity marketplace. As
such, they have the potential to deliver outcomes that are 10% to 20% higher.7
SOME RETIREMENT INCOME PRODUCTS ARE MORE CONFUSING THAN OTHERS
Institutional retirement income options available today offer benefits that range from maximum
income flexibility to maximum income guarantees. A systematic withdrawal plan (SWiP) is at one
end of the spectrum, offering full flexibility but few guarantees — thereby exposing retirees to
market volatility and longevity risk. At the other end of the spectrum is a fixed income annuity
that offers maximum guaranteed income for life.
Along the middle of the spectrum are variable deferred annuities offered to participants during
the accumulation phase, such as guaranteed lifetime withdrawal benefits (GLWBs), guaranteed
minimum income benefits (GMIBs) and guaranteed minimum withdrawal benefits (GMWBs).
These products, which provide income flexibility and guarantees at an additional expense, include
features that are designed to overcome a number of objections that participants have to annuities
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(e.g., lack of liquidity, an inability to benefit from investment gains, etc.). Because these products
are typically embedded in the plan’s target-date default option into which employees who make
no elections are automatically enrolled, some sponsors believe they serve the dual purpose of
providing opportunities to participate in the investment markets while at the same time delivering
income guarantees for participants who might otherwise be biased against annuities.
Although the sheer number of DC plans offering these income products may – on its face – seem
impressive, experience has shown that there is a fairly low take-up rate on these products – most
likely because they are too complicated for the majority of plan participants to understand and too
complicated for sponsors to successfully communicate. While many participants and sponsors may
find the “concept” of guarantees attractive, nearly six in ten plan sponsors (58%) do not believe
that withdrawal solutions with minimum guarantees are easy to understand for the average DC
plan participant.
Certain Approaches That Involve Variable Annuities, Particularly Those That Try To
Address Every Need, Can Be Complicated For Participants During Their Saving Years
In a GMIB approach, participants buy into a fund that provides a minimum income benefit
with the potential for upside appreciation. The upside appreciation comes from the
investment performance of the fund that is associated with the annuity; typically, this is a
balanced fund. The minimum (or floor) income benefit is determined by using conservative
annuity purchase rates. Upon retirement, the participant will receive the higher of the
minimum income guarantee (the floor) or the income generated by the current annuity
purchase rates applied to the market value of the account. Once the annuity is purchased,
generally there is no liquidity. The participant may choose not to annuitize and withdraw the
market value of his or her account in a lump sum.
The GLWB (also known as the GMWB) approach combines systematic withdrawals with a
potential income guarantee. These products are often structured as a DC plan investment
(i.e., target-date or risk fund) that can guarantee a fixed withdrawal amount regardless of
a participant’s actual account balance at retirement. At a specified age the assets are moved
into a guaranteed fund component and “wrapped” with a guaranteed percentage withdrawal
amount, say 4% or 5% of the asset base. Each year, positive investment performance will
result in a reset or “step-up” of the asset base to the increased current value of the assets;
however, the asset base is kept unchanged at the prior level in the event of a market decline.
Upon retirement, the participant is eligible to withdraw the guaranteed withdrawal amount,
while leaving the remaining assets in the market. However, excess withdrawals over a stated
amount and other participant actions may trigger penalties and/or reduce the guaranteed
withdrawal amount.
FIXED-INCOME ANNUITIES AS DISTRIBUTION OPTIONS: 401(K) “COMPLETERS”
Offering fixed income annuities as a plan distribution option allows retiring participants to use all
or a portion of their plan assets to purchase a guaranteed fixed income stream for life. Sometimes
referred to as 401(k) “completers” because they round out or “complete” the retirement readiness
process, the most common of these are immediate fixed income annuities and qualifying longevity
annuity contracts or QLACs. Unlike products designed for maximum income flexibility, income
annuities do not seek to address all plan participant objections in a single product, but permit the
participant to break the retirement income decision down into separate steps that can be as simple
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or intricate as the participant chooses, and more cost effective.
In contrast to GLWB, GMWB and GMIB approaches – where by virtue of the investment
management fees associated with these accounts participants are, in effect, paying for access to
upside market potential – immediate fixed income annuities and QLACs used in combination with
systematic withdrawal payments (a SWiP approach) afford participants the flexibility to create their
preferred amount of guaranteed lifetime income.
Income Annuities As Distribution Options: A Plain And Simple Approach
Immediate fixed income annuities offered as a distribution option allow participants to
use a portion of their retirement savings to purchase an immediate income stream that is
guaranteed for as long as they live, while their remaining assets can be more efficiently
invested to potentially grow their overall portfolio. Because income annuities produce the
highest level of guaranteed income per dollar of assets, an average retiree would need to
save about one-third more to replicate the power of the lifetime income annuity. While a
retiree trades off a bit of liquidity for the portion of assets put into an annuity, he or she
likely will have more income to spend overall.
A qualifying longevity annuity contract (QLAC), also known as “longevity insurance,” is a
type of deferred fixed income annuity (DIA) where income payments begin at an advanced
age – typically 80 or 85. Approved by the U.S. Treasury Department in July 2014 for use as a
distribution option in employer-sponsored individual account plans, QLACs can be purchased
with the lesser of 25% of a participant’s account balance, or $125,000. Assets allocated to
the purchase of a QLAC are not included in the balance used to calculate required minimum
distributions (RMDs) for participants beginning at age 70½. By lowering the annual RMDs
that participants must take in early retirement, more money can remain in the participant’s
DC plan with the potential to grow. Additionally, by delaying payments to a later age, the
participant can increase the income amount that is possible when the QLAC’s guaranteed
income payments begin. At the time of purchase, features can be added to a QLAC that
offer inflation protection and provide for a return of premium (ROP) death benefit payable
to designated beneficiaries in the event the participant dies. However, QLACs generate the
most amount of income with the fewer options participants elect.
RETIREMENT INCOME IN ACTION
How an Immediate Income Annuity Compares to a SWiP Approach:
Let’s assume a participant has identified the need for $600 of monthly income replacement in retirement.
Purchasing an immediate income annuity at age 65 with $100,000 would guarantee this amount to the
participant, each month for life. Under the SWiP approach, if the participant at age 65 allocates $100,000
to an investment account at an assumed 4% annual rate of return, withdrawals of $600 each month
would deplete the account by the time the participant reaches age 85. Using a portion of savings, this
participant could purchase lifelong income to cover fixed costs via an annuity, with the balance of savings
left in the plan and available for use as he or she chooses.
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Immediate
Income Annuity
Provides $600 per month for Life
Provides $600 per month to age 85
Alternative
Investment
Initial Investment of $100,000
85
+4%/yr
This is a hypothetical illustration for illustrative purposes only. The immediate income annuity illustrative payout is based upon
the Annuity 2000 Mortality Table D, a 4% interest rate assumption, no expense load and a single life only payout. For the
alternative investment, the illustrative funds being withdrawn monthly are based on an annual 4% rate of return assumption.
Comparing an Immediate Income Annuity to a GLWB Approach
Let’s assume a participant contributes $10,000 to a retirement savings account beginning at age 45, and
contributions continue for the next 20 years. Under one scenario, at age 65 the participant uses the funds
accumulated in the plan to purchase a single life immediate fixed income annuity using actual MetLife
purchase rates as of 1/1/2016 (unisex DC plan rates are applied). Under another scenario, the participant
purchases a GLWB contract where the GLWB feature is activated at age 55 at which time a 1% guarantee
fee and 5% guaranteed income rate are applied.
Under both scenarios, the funds are invested 85%/15% in equity fixed at age 45, then move to 50%/50% in
equity fixed at age 55, and remain constant thereafter. Fixed income returns are based on historical Barclays
U.S. Aggregate Bond Index returns. Equity returns are based on historical S&P 500 returns. The investment
period used here runs from calendar year 1996 through calendar year 2015.
• Account Balance: Annuities purchased at retirement allow more time for savings to accumulate
in the plan. Additionally, fees associated with the GLWB can be significant, resulting in lower
accumulated account balances. In this example, at age 65, the balance available to purchase an
income annuity would be 8% higher than the balance in the GLWB account ($417,000 vs. $385,000).
Income Annuity Versus
In-plan Lifetime Withdrawal Benefit (GLWB)
Plan Balance at Age 65
$417,000
$385,000
Plan balance to
purchase an
income annuity
GLWB plan
balance
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• Guaranteed Income: Income annuities offer the highest payout when compared to any other
annuity option. In this example, the yearly payout from an income annuity would be 44% more
than the GLWB yearly payout beginning at age 65. After 20 years in retirement, the total payout
from the income annuity would be $556,000 versus $385,000 from the GLWB.
Income at Age 65
Provides $27,800/yr
Guaranteed Income
Provides $19,250/yr
Guaranteed Income
Income
Annuity
GLWB
Based on plan
balance of
$417,000
Based on plan
balance of
$385,000
• Guaranteed Income, plus liquidity and flexibility: Using only a portion of a participant’s account
balance to purchase an income annuity at age 65 would provide the same $19,250/year payout as
a GLWB – but with an additional $128,000 in liquid funds remaining. With the GLWB, any amount
that is taken from the account will reduce the guaranteed benefit.
Income & Liquidity at Age 65
Each will provide $19,250/yr
Guaranteed Income
$128,000 remaining
liquid funds
Cannot be liquidated
without impacting the
income guarantee
$289,000 for income
annuity purchase
$385,000
Plan Balance
Plan Balance used to
purchase
Income Annuity
Lifetime Withdrawal
Benefit (GLWB)
Plan Balance
For sponsors concerned about the administrative complexities of offering income products,
annuities purchased at the point of retirement pose significantly fewer recordkeeping and
portability challenges than in-plan solutions. From a communications perspective, annuities as
distribution options are simpler and, therefore, easier for participants to understand – involving far
less education challenges than income options included in a plan’s investment lineup.
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Comparison of Retirement Income Options
Feature
SWiP
GLWB
Income Annuity
Guaranteed Income for Life
No
Yes1
Yes
Guaranteed Payment Amount
No
Yes1
Yes
Provides Liquidity
Yes
Yes
No
Variable Investment Options
Yes
Yes
No
Eliminates Asset Fees
No
No
Yes
Immune to Market Volatility
No
No
Yes
Simple Implementation
Yes
No
Yes
Easy to Understand
Yes
No
Yes
Easy Portability
Yes
No
Yes
Inflation Protection
No
No
Yes2
All product guarantees are subject to the financial strength and claims-paying ability of the issuing insurance company.
1 Excess withdrawals may affect guarantee
2 If COLA rider is chosen
CONCLUSION
When assessing the benefits of adding a retirement income component to a DC plan, it is worthwhile
to note that current maximum income flexibility options – designed to offer the potential to
both grow savings and guarantee income – have ironically resulted in even greater complexity for
participants. If the ultimate goal is to enable the opportunity for guaranteed lifetime income – plain
and simple – DC plan sponsors should give careful consideration to plan design options that avoid
unnecessary complication. As the benefit of time will likely prove, plan participants can do no better
than the guaranteed payout from an income annuity distribution option.
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M
etLife 2016 Lifetime Income Poll
M
etLife Retirement Income Practices Study, July 2012
M
etLife 2014 Qualified Retirement Plan Barometer
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lan Glickstein, Watson Wyatt Worldwide Inc., Dallas Witnesses to a Revolution, Pensions & Investments 40th Anniversary Issue October 14, 2013
T he 4 Percent Rule Is Not Safe in a Low-Yield World, Michael Finke, Ph.D., CFP®; Wade D. Pfau, Ph.D., CFA®; and David M. Blanchett, CFP®, CFA®
M
etLife 2016 Lifetime Income Poll
S tanford Center on Longevity, see article A Step Closer to Fixing a Serious 401(k) Flaw
1610-692423 CS
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© 2016 METLIFE, INC.
Metropolitan Life Insurance Company
200 Park Avenue
New York, NY 10166
www.metlife.com/retirementincome