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Take the Money and Run

While HR leaders spend a lot of time educating employees on the need to increase their retirement savings, they often fail to educate themselves about the newly created payout programs that employees can opt into when they get ready to retire. Such programs -- which can offer workers a stable monthly income -- should be incorporated into plan designs, experts say.

Thursday, April 28, 2011
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Defined-contribution-plan assets are hitting record levels, but more than one-quarter of Americans are worried they won't have enough money for a comfortable retirement.

To help employees plan for retirement, many HR leaders and retirement experts focus on increasing 401(k) savings rates, but they should also focus on the way employees draw-down their savings when they retire, experts say.

"I think it is absolutely an issue that HR professionals need to be paying attention to," says Brad Kuebler, a principal in the Minneapolis office of Milliman, an actuarial and consulting firm. "There really is a lack of options for [workers] when they get into the drawdown phase. ... That is a pretty critical time to start doing research and figuring out what to do."

Assets in 401(k) plans reached $3.075 trillion in 2010, according to the latest Marketplace Update report by the Society of Professional Asset-Managers and Record Keepers (SPARK) and the SPARK Institute, based in Simsbury, Conn.

At the same time, 27 percent of American workers say they are "not at all confident" they will have enough money for a comfortable retirement -- the highest level ever measured in the Retirement Confidence Survey by the Employee Benefit Research Institute.

What may be even worse is that the other three-quarters of Americans aren't worried -- at least not yet -- as most surveys point out the inadequacy of retirement savings for most workers.

A recent Class of 2011 survey by Prudential finds that nearly one-quarter (22 percent) of people due to retire in 2011 are cancelling their plans because they can't afford to stop working.

Another survey, the National Retirement Risk Index, estimates that 51 percent of U.S. households will see a "big decline in their living standards when they retire," said Alicia Munnel, director of the Center for Retirement Research at Boston College in Boston.

Munnel was one of several panelists on "The Future of Retirement" webinar hosted by New York-based Mercer earlier this month.

The typical participant in a 401(k) plan, she said, has about $78,000 in his or her account, which -- assuming the standard 4-percent drawdown each year -- equates to about $3,200 a year for that retiree, she said.

"I think people are going to be shocked when they get to retirement and see how little money they have and how little that provides as a source of monthly income," she said. "It's expensive to support yourself for 20 years without working."

Christine Marcks, president of Hartford, Conn.-based Prudential Retirement, says the typical balance is much higher -- $160,000 -- yet even that will only provide an income of $12,000 a year.

"The point," says Betsy Dill, a Los Angeles-based senior partner at Mercer, "is, whether it's $78,000 or $160,000, it's not a lot."

Proposed federal legislation -- the Lifetime Income Disclosure Act -- may prompt workers to take a more proactive approach to retirement, says Jamie Kalamarides, senior vice president of retirement strategies and solutions at Prudential in New York.

The bill, introduced by Sen. Jeff Bingaman, D-N.M. would require 401(k) plan sponsors to include information on benefits statements about each individual's estimated future monthly retirement income, based on their current account balance.

The bill, which was introduced but failed to be adopted in the previous session of Congress, is co-sponsored by Johnny Isakson, R-Ga., and Herb Kohl, D-Wis. In the current session of Congress, it has been referred to the Committee on Health, Education, Labor and Pensions, according to GovTrack.US.

Kalamarides says the law has "widespread support" and he expects it to be adopted as a rider to other legislation, rather than be approved on its own.

But while such information may compel some individuals to increase their savings, more is needed on the other end of the process, he says. Plan sponsors need to better inform individuals and offer better ways to stretch out their savings so they last through retirement.

Too many workers, he says, just take a lump-sum payment instead of converting the savings into an instrument that offers monthly payments throughout retirement.

Dallas Salisbury, president and CEO of Washington-based EBRI, says increased longevity is placing greater pressure on retirement savings.

In recent years, he says, "there has been more and more innovation ... [and] a greater range of program designs that will help individuals try to make sure -- or absolutely be sure -- that they don't run out of money before they run out of life."

Insurance companies and investment advisers are offering newly created income products that are "quite different concepts," he says. "They both fit different profiles and different needs."

A guaranteed lifetime-income product, offered by most major insurance companies, allows individuals to lock in savings at a certain market level and that rate would remain, even if the market went down later, "as long as they don't start withdrawing the money until [they] hit retirement age," Salisbury says.

The down side, he says, is that many individuals change jobs and withdraw their funds before retiring. If they do withdraw their funds, they will face fees and the potential loss of value, depending on the market value at time of withdrawal.

Kuebler adds that other potential detractions are the potential high cost to enroll in such a product and the difficulty facing plan sponsors who must explain the concept and plan features.

Also, Salisbury says, since an individual's life savings are in the possession of a single company, the plan sponsor or fiduciary needs to select a "very well-rated, stable, soundly managed insurance company."

That issue of solvency is one of the reasons some plan sponsors have opted in the past few years to discontinue offering an annuity option to 401(k) participants, says Kuebler. Other issues included the high cost and administrative difficulties.

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As for products offered by investment advisers and mutual-fund companies, they do not guarantee a payout as do insurance products, says Dill, who is a former member of the Department of Labor's ERISA Advisory Council. But they do offer a mostly stable payout and an easier way to withdraw funds.

Salisbury says participants can select how many years they want their account balance to last, say 15, 20 or 30 years. The funds are managed to try to meet that goal, but monthly payouts may vary, depending on the market.

In down years, participants may be asked to take a lower annual payout to ensure their balance lasts for the selected 15 to 30 year term, he says. If they refuse, they take the chance that their money won't last as long as they had planned.

Other advisers don't ask; the plan allows them to automatically reduce the payout to correspond with the market, he says.

Salisbury offers another option: purchasing longevity insurance -- which provides individuals with a set income, typically after he or she turns 85 -- in combination with one of the managed investment options.

By enrolling in longevity insurance -- which typically provides a set income to individuals 85 years and up -- the individual's 401(k) account balance needs to last only from, say, the time the person is 65 until he or she is 85, at which point the longevity insurance kicks in. That shorter timeframe would provide the participant with a higher annual payout, Salisbury says.

And the cost of longevity insurance is generally reasonable, he says, because 85 is longer than most life expectancies.

According to the latest numbers from the Centers for Disease Control and Prevention, women have a life expectancy of 80.4 years; for men, it is 75.4 years.

"There are a number of different options," Dill says. "What we are suggesting is that a plan sponsor could put together a menu of options that would appeal to participants with different objectives."

 

Kalamarides says plan sponsors are hesitant to offer such plans to workers, however, because the government does not provide a safe harbor to employers. Most fiduciaries are "rightly afraid of unwritten rules" by federal regulators.

He says rules may be closer to being written, however, as the U.S. Departments of Treasury and Labor have requested information on drawdown programs, and the topic is on the DOL's regulatory agenda this year.

Both Dill and Kuebler, however, believe a decision won't be coming anytime soon.

She also says the issue of safe harbors is a "red herring." The DOL, she says, only requires fiduciaries to show "demonstrated prudence, policies, process and monitoring" of selection decisions.

The issue is really more of a reluctance on the part of plan sponsors to evaluate the wide variety of products available -- and to make decisions on their viability for inclusion in defined-contribution plans, she says.

And if sponsors feel that way, imagine how the plan participants feel.

"I would encourage plan sponsors to think about the cost of [pre-retirement] education for participants," she says, "and figure that into the cost of running the plan."

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