To be truly successful, today’s retirement plan solutions must place participants’ needs first.
By Don Dady.
In recent years, we have seen a massive shift in the retirement landscape. With defined contribution (DC) plans as the predominant source of retirement income, millions of Americans face significant financial shortfalls. And they face them alone.
DC plans today are designed to get participants to retirement, but they are not designed to get participants through retirement. On top of millions of Americans’ facing significant financial shortfalls, this structure leaves them ill-equipped to navigate through the risks they will face in retirement.
It’s time to change the way Americans prepare for retirement. Retirement isn’t the finish line. It’s the starting point.
Preparing for the journey
From an investment perspective, diversification is key, but traditional asset allocation only goes so far. The risks people face during the accumulation years are very different than those they will face during retirement. During the accumulation years, as participants live through market cycles, proper diversification or asset allocation can minimize volatility and help avoid severe losses during market recovery periods. In contrast, during the income stage, the market cycle stops when the participant liquidates assets to provide income. Liquidating assets during down market cycles strips away the portfolio’s ability to recover – frequently referred to as “sequence of returns risk.” Proper diversification is critical, but it cannot mitigate this decumulation risk.
From a demographic perspective, individuals are living longer, so they have to plan for their savings to fund a retirement of 20 to 30 years or more. Although living a longer life is great, it exposes individuals to all of the other financial risks in retirement, including high health care bills, rising inflation, and market volatility. While proper asset allocation can help to minimize volatility and avoid severe losses, no one can asset-allocate their way out of longevity risk.
From a holistic perspective, when retirement income becomes the measured outcome, we must consider how an annuity offering lifetime income can mitigate the risks inherent in a traditional retirement portfolio. Specifically, an annuity with lifetime income can mitigate the risks outlined above.
If DC plans do not provide lifetime income protection, they fail participants in 3 key ways
First, as outlined above, many participants depend on their DC plan to supplement their retirement income. If they are planning to withdraw 4 to 5 percent or more, there is a significant risk they will run out of money if they don’t get lucky.
Second, participants have no idea how much they can safely spend in retirement. One study reported that 33 percent of those interviewed had no idea how much they could safely withdraw and that roughly 25 percent expected to be able to withdraw more than 10 percent of their retirement savings each year.
Many individuals underspend in retirement for fear they might run out of money, and, of course, those who overspend increase the risk that they will run out of money.
Third, while some DC plans offer lifetime income solutions at age 65, waiting until age 65 is expensive. By focusing on generating income earlier in the planning process, as one is approaching retirement, a lifetime income solution can be far less expensive, translating into much higher income in retirement.
From a mainstream, retirement-ready products perspective, not including in-plan income solutions as a cornerstone within the Qualified Default Investment Alternative (QDIA) is reckless.
In all fairness to the industry, before the Secure Act, in-plan income as a QDIA wasn’t much of an option. Post-Secure Act, the industry needs a fresh perspective. There are various ways to efficiently introduce in-plan income integrated into a retirement portfolio. To be truly successful, today’s solutions must place participants’ needs first and address traditional barriers to adoption, such as prohibitive costs, overly complex solutions, the sacrifice of returns, and the loss of liquidity and access to funds. It is time for some innovation.
The industry has been looking at the wrong endpoint for too long. It’s time to reframe retirement savings plans to retirement income plans using a new measuring stick. That measuring stick should look at what is truly in the best interest of participants. Although fees will always be a part of the due diligence process, it’s time to step back and focus on income as the outcome.
Bottom line: providing employees with a financially secure retirement goes beyond enrollment in a DC plan. For many, the answer lies in a fresh perspective focused on solutions that efficiently integrate lifetime income into a retirement portfolio. Because retirement should be a reward, not a risk.
Don Dady is a co-founder of Annexus, a Scottsdale, Arizona-based company dedicated to designing and marketing innovative products that help individuals grow and protect their retirement savings. In early January 2019, Blackstone acquired a minority stake in Annexus, and part of that capital has helped build out the new division, called Annexus Retirement Solutions. Annexus Retirement Solutions is focused on developing next-generation product & portfolio solutions for institutional clients. The company also created the Annexus Data Exchange (ARDX) to connect investment managers, recordkeepers, insurers, and CIT Trustees efficiently to make these solutions available to the market in a timely manner.