3 Considerations for Distributing Retirement Benefits

There are several key considerations for a Defined Contribution (DC) plan sponsor interested in helping participants through retirement. Here are a few that are unique to the distribution of retirement benefits:

1) Keep the Party Going

You’ve been a great partner to your employees, providing a low-cost, efficient means to help your employees save for retirement. Keep it going by allowing them to continue to use the DC plan as a vehicle for their needs in retirement:

  • Low Cost: From a fee perspective, your employees may not be able to do better than what you are able to provide by leveraging the scale and buying power of your retirement benefits as a whole.
  • Sound Advice: Managed account services can offer comprehensive, customized distribution recommendations to participants that can include appropriate recommendations to an annuity, if available in the plan and appropriate for the participant.
  • Retirees Help Current Employees: Administrative costs are typically priced as a per-participant fee, and investment expenses are typi­cally asset-based fees. In both instances, having retirees in your retirement benefits should lower both the admin­istrative and investment expenses because more people in the plan lowers average administrative expenses, and retiree balances tend to be larger than active employees.

2) Keep it Real

The goal of many retirees is to generate some amount of income during retirement, increased annually by inflation. Therefore, inflation is a very important consideration when working toward this goal. Real assets, or asset classes that generally rise with inflation, can be valuable investment options for retirees. Some examples of common real assets include TIPS, real estate, commodities, etc. For some plans, it may make sense to consider a single multi-managed “real asset” option to provide participants with a one-off way to gain exposure to real assets.

3) Guaranteed Income for Life

Retirement may end up being 30 years or more. Generating income for such an extended period is no easy feat, especially given today’s low bond yields. Therefore, including some type of guaranteed income option in a DC plan is an important consideration, but one with interesting fiduciary considerations. Fortunately, there are ERISA standards for selecting annuity providers. We address some of those guidelines and additional concerns below:

  • Keep Good Records

Plan sponsor DC committee members come and go, but an annuity can last forever (or at least 30 years). Therefore, it’s essential to keep detailed records of the due diligence procedures for selecting and monitoring any type of plan annuity option.

  • Portability

How are participants who want to roll out of the plan affected? Portability is important, given participant behaviors, especially if the participant has paid for some type of guaranteed benefit and loses this insurance if he/she rolls out of the plan.

  • Peel Back the Onion

Annuities can be incredibly complex vehicles and come in many shapes and sizes. Therefore, it’s important for plan sponsors to really understand what they’re buying and how it might be able to fit the needs of their participants.

  • Bring in the Expert

Given the complexity of the annuity decision, it makes sense to seek counsel from experts. While many plan sponsors may be comfortable using various quantitative tools for screening traditional investment options for their retirement benefits, such tools don’t really exist in the guaranteed income space.

  • Gauge the True Cost

Annuities, as a form of insurance, should not be expected to result in a positive value for the average participant. While some participants will be better off purchasing an annuity than investing the money themselves in a portfolio and taking withdrawals, insurance companies are in business to make a profit and are generally quite good at pricing risk. Understanding these costs and how they affect different participants, is an important component in the selection and monitoring process.

  • Participant Experience

The final consideration is participant communications and the participant experience when owning and using the guaranteed income option to fund retirement. One size does not fit all, and therefore different guaranteed income options are likely to work better for different types of DC plans.

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David is currently the head of retirement research for Morningstar Investment Management LLC.  In this role, he works to enhance the group’s consulting and investment services and serves as the chair of the Advice Methodologies and Automated Strategies subcommittee, which is the working group responsible for developing and maintaining all methodologies relating to wealth forecasting, general financial planning, automated investment selection, and portfolio assignment for Morningstar Investment Management LLC. He does research primarily in the areas of financial planning, tax planning, annuities, and retirement. His research has been published in a variety of industry and academic journals and has received a number of awards. He is a frequent speaker at industry conferences and is regularly quoted in the national media.  When David isn’t working, he’s probably either out for a jog or playing with his two kids.

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