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The emergence of a new generation of protected retirement income solutions
Protected retirement income solutions have existed in some form for more than a century. In the last few decades, they began to evolve, driven largely by market demand for more transparency and lower fees. The most significant difference is that today’s offerings combine fund and insurance innovation.
The first generation of these products was not portable or liquid and typically featured a single asset class, annuity contracts. TDFs offered in defined contribution (DC) plans provided access to mutual funds, with basic asset allocation of stocks and bonds guided by a standard target date for withdrawal or the beginning of decumulation.
Starting in 2006, the second generation of PRI products combined TDFs and annuities to offer access to index funds and a glide path based on workers’ retirement timelines. They did not solve for portability or liquidity, however. A new class of TDFs and managed drawdown funds employing mutual funds and collective investment trusts (CITs) aimed to do just that. However, without guarantees, income could fluctuate.
Today’s PRI products combine CITs and TDFs with guarantees. Typically, participants have access to a range of underlying index funds (e.g., the S&P 500 Index Fund, US Aggregate Bond Index Fund). They are both portable and liquid and are not proprietary to individual recordkeepers.
Chapter
Common misconceptions and persistent myths
Despite these significant enhancements, misconceptions persist about the value and efficacy of PRI solutions.
According to our research, many stakeholders, including experienced industry professionals, associate PRI solutions with:
- Participant fees or penalties to transfer or withdraw funds
- Fiduciary risk for the plan sponsor
- Lack of portability of funds for the participant
- High administration costs for the plan sponsor
- Solution complexity for the participant
The reality is that most of the protected retirement income products on the market today have been designed to address these issues. They are portable, can be rolled into other types of plans and do not compromise plan sponsors’ and advisors’ fiduciary duties. Fees and penalties for withdrawal and transfer have been eliminated or reduced. The costs for employers, including administrative costs, are often lower than they were previously. Concerns about complex enrollment and investment processes for participants can be addressed with effective communication plans.
Plan consultants have additional concerns related to the criteria they use to recommend products to employers. For example, in our research, many referenced a belief that these products are not suitable for individuals with lower account balances. They also referenced the fear of changes to existing solutions and recommending solutions that few, if any, companies have adopted. The loss of potential wealth management clients and limited transparency due to the lack of a common data set were other concerns.
While our research makes clear that the latest version of PRI solutions largely addresses many common concerns, the industry must address the lack of a common data set and navigate potential impacts on the wealth management business. These issues must be addressed if PRI solutions are ever to achieve widespread adoption.
Chapter
Quantifying the value for plan sponsors: lower costs, increased asset retention, higher participant satisfaction
Our research also framed the potential benefits for plan sponsors. The findings indicate that the financial benefits for employers and enhanced outcomes for participants form the heart of the value proposition for PRI solutions.
Reduced employer costs
While many employers seek to support their employees’ long-term financial well-being, their costs rise as plan participants delay their retirement to accumulate more funds. The prevalence of these delays makes them an increasingly urgent concern.
The financial impacts – primarily in the form of higher salaries and benefit costs – are significant. Nearly half of employers say they are paying higher salaries for longer tenured employees and 38% said health and benefit plans are becoming more expensive due to delays.
Our calculations suggest that labor and benefit savings per delayed year of retirement are equivalent to $26k per year per employee. This calculation is based on median salaries across four levels of hierarchy. Once the individual at the top of the hierarchy retires, other individuals in the chain of command take on additional responsibilities with an increase in salary. A new joiner is hired to fill the lowest role of the hierarchy with an entry-level salary.
For the largest employers (e.g., those with 100,000 employees) that widely adopt PRI solutions, labor and benefits cost reductions could total up to $9.75 million, if product adoption is 60%.
Increasing asset retention
There is also clear upside for employers to retain assets within their retirement plans and minimize asset outflow. That’s true because plan administration fees decrease on a unit basis as plans scale up. Protected retirement solutions have the potential to reduce outflows and increase asset retention. Asset outflows from DC plans are increasingly leading to smaller balances for participants and inefficiencies for plan sponsors.
Our research showed that asset retention by adding PRI solutions may lead to annual cost avoidance of mid to high five figures per plan. While that may not seem like an enormous financial benefit, it may be meaningful to some employees. Further, PRI solutions enable employers to offer a potentially high-value post-retirement benefit that many employees are likely to appreciate.
What PRI solutions offer participants
For participants, superior results and outcomes point toward increased financial well-being. Disincentives for withdrawing lump sums strengthen many tax strategies and improve returns after retirement. Relative to participant confidence, these products can alleviate concerns related to outliving their retirement savings or not having enough income to support their pre-retirement lifestyle.
In other words, participants can feel more confident about their retirement readiness. Further, participants can easily access this benefit via their employer without the need to engage with a financial advisor or pay higher fees, as is typical with similar solutions offered outside of employer-sponsored plans.
Increased participant satisfaction can help promote employee loyalty, a significant consideration in a tight labor market. To realize that benefit, employers may need to ensure that participants understand the value of PRI products and how to use them. That education process can take advantage of participants’ strong desires for protected retirement income solutions, which research from Nationwide has confirmed.
Given such clear and compelling benefits, there is every reason to believe that the market penetration of PRI solutions can grow significantly in the near future. Realizing this increased uptake will require the development of clear “rules of thumb” and leading practices for participant communication and education so that employees use these products in the most appropriate and beneficial ways.
Chapter
Conclusion: a retirement income solution whose time has come
Plan sponsors and consultants should thoroughly evaluate the new generation of products, especially in light of how much they have evolved.
Our research provides detailed quantitative evidence of potential benefits, including potentially better outcomes than TDFs can offer in many circumstances, lower administrative costs, more flexibility and increased portability and liquidity, compared to previous generations of PRI solutions.
While the financial track record of the most recent generation of products is limited, the fundamental differences in solution design make them an entirely new breed when compared to previous versions. Our research findings demonstrate that many of the old misconceptions about value and complexity no longer apply to the current crop of PRI products.
Summary
The time has come for more plan sponsors to offer PRI solutions, provided the industry can work through issues related to transparency, comparability and potential impacts on other parts of the business.
