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Individual comments on  

Income options for beneficiaries in retirement plans

from topics discussed at the recent Society of Actuaries conference ‐‐ 

20/20 New Designs for a New Century

June 3, 2010

Introduction:

While there were a number of applicable topics discussed at the just completed Society of Actuaries

conference considering the merits of various changes to current benefit plan arrangements (the

“Conference”), four stand out as potentially being most relevant to the issue of income options for

beneficiaries in retirement plans – particularly beneficiaries in Defined Contribution (DC) plans – about

which the Department of Labor has recently inquired.

The first two make greater use of the existing Qualified Default Investment Alternative (QDIA) regulatory

base.  One potentially addresses the financial literacy impediments many current DC plan participants

face that currently constrain their ability to fully realize the post retirement income potential of

contributions they and their employers make.  The second addresses a potential way to increase both

overall access to and take‐up rates on existing DC Plans beyond the respective 61% and 70% rates that

had already been achieved, as reported in the Department of Labor’s most recent report on Employee

Benefits in the United States (March 2009).

The third relates to the benefits of adding some form of standardized calculations about potential benefit

levels at retirement to current DC plan reporting. The Social Security system has incorporated such

standardized calculations in their reports and some suggested additions to DC plan reporting may also

remedy this observed shortcoming.

The fourth relates to a discussion of the merits of creating a related set of regulations to the existing

QDIA regulations that might usefully help to guide core best practices for lifetime income alternatives for

the income phase.  Such standards would be able to equally apply for combined solutions that wanted to

serve both phases.  Much like the QDIA standards have, such related regulations would not preclude

other alternatives from being offered.  Rather, they would just help to differentiate core ones,

particularly for plan participants and retirees who lack the financial literacy to fully evaluate all of the

possible alternatives that might be available to them when they are seeking to turn their accumulated

assets into retirement phase income.

All of the above four observations have the additional merits of requiring potentially only minor

modifications or extensions of existing regulatory and institutional frameworks.

   
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Comment 1:  Addressing the implications of low financial literacy levels of DC plan participants

One observation that has received increasing recent attention is about the opposing influences of (i) the

ongoing requirement that DC plans offer sufficient choice to their participants while at the same time (ii)

providing for and sustaining the level of financial literacy needed for participants to make effective

choices amongst the alternatives so offered ‐‐ suited to their age and career status ‐‐ that might enable

them to realize better post‐retirement incomes from the contributions they are making.  This has been

well documented in current behavioral finance literature and in comments already submitted to the

Department of Labor in response to their request for comments (RIN 1210‐AB33).

The results of current shortcomings in providing for and sustaining needed levels of financial literacy

broadly across DC plan participants have been wide distributions of asset allocation choices across

participant accounts that may not, and likely are not, compatible with the objective that may be best

suited for many of those participants (i.e. to be investing as if their DC funds are to be their primary

supplement to social security income upon retirement).  To be sure, there is a portion of DC plan

participants for which their asset allocation choices are well suited; however, there is a material enough

proportion for which this appears not to be true, such that some additions to the current QDIA

regulations might be highly beneficial.  This will be especially true if there is to be any expansion of the

participant base as is addressed below in Comment #2.

The observation from the recent Conference that a slightly expanded use of the QDIA regulations that

might be able to substantially address this problem is covered below.

The modifications would be to  

1) require all DC plans to offer at least one QDIA qualified fund,

2) require all DC plans to default all new participants into that fund, and

3) require all DC plans to restrict those new participants from adopting allocations to any non‐QDIA

fund offered by the plan until the later of (i) six months or (ii) the time for that participant to

complete two plan sponsored education events.

This will build on the basic acceptability of QDIA funds to create a safe harbor for new participants,

without rushing them into making long term choices or establishing potentially long term practices for

which they may not be fully prepared.  The requirement that the participant further identify that they

feel ready to make alternative choices will also create a safety bias for participants without unduly

restricting those who feel that they have achieved the level of financial literacy they need to make

choices about other, non‐QDIA asset allocation choices for themselves.

   
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Comment 2: Increasing Access and Take‐up Rates on DC plans through simplified offerings

Though it is encouraging that 61% of private industry workers – a meaningful percentage – have access to

DC plans and take‐up rates stand at 70%, according to the most recent Department of Labor National

Compensation Survey (March 2009), two simplification solutions surfaced at the Conference that might

further improve these statistics and further broaden participation.

The first simplification solution, required auto enrollment, and on one paper, auto enrollment combined

with a small (1.5%) required employer minimum contribution, provided for two possible modest changes

that would demonstrably and respectively increase both participation and levels of early stage employee

engagement.  The combination would also bring early attention to newly hired employees about the

presence of the plan, to contribution levels and to their readiness to make good asset allocation choices

going forward.

When these are combined with the safe harbor delay and education period discussed above enabling

interim contributions to remain channeled and invested in a QDIA choice, these fairly long term decisions

can then be made outside of the usually confusing period for employees that characterizes the early

months after their initial hire date – without losing the benefits of starting the employee’s contributions

from that first date of hire.

These steps can improve upon the participation, or the related take‐up, statistic.

The second simplification solution addresses the question of increasing access.

Many have observed that the complexities of creating and properly maintaining DC plans for some

companies is a significant enough burden – either because they are small and lack the minimum

administrative scale to take on this requirement, because their industry operates with large numbers of

temporary workers for which the additional hiring overhead might be viewed as excessive, because their

industry operates on margins so narrow that such additional overhead would be a burden, or for other

reasons – that they have felt unable to go through the process of setting up a full plan and preparing for

its administration.

The suggestion that was presented at the Conference was to have a form of 401(k) that would be entirely

comprised of one or more QDIA funds.  Such plans could be administered at minimal additional cost

outside of employer sponsors ‐‐ even by 401(k) TPAs.  The only obvious additional requirement for such

simplified plans might be restrictions on administrative fees to, for instance, no more than

$200/participant/year and for fund expense ratios to not exceed 0.99 in order to qualify.

Such simplified plans could become broadly available to many employers who currently have very

legitimate reasons for not being able to bear the administrative costs of maintaining such plans.  As most

of these companies also are likely to use third party payroll providers, such as ADP, the complexities of

directing a portion of each payroll run to these external TPAs would be minimal as well.

   
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Comment 3: Adding reporting on the potential for differing levels of retirement phase income

Behavioral finance literature and other comments already submitted to the Department of Labor have

noted that, especially given the low levels of financial literacy that prevails across many DC plans, it is

difficult for most current and likely future plan participants to regularly and easily make the calculations

needed to determine what levels of retirement phase income might be achieved given their current

contribution rates, those of their employer and the time they have to retire.  Calculators are available,

but there are no standards or guidelines as to their use and few if any limitations that might restrict their

incorrect use.

With the appropriate disclosure about forecasts relating to the future and the possible impact of future

events, it is possible for a standard set of assumptions to be defined that could be universally utilized in

DC plan reporting to provide information about the potential for different retirement phase income

levels to go along with the required disclosures on fund balances in regular reports.

Such a calculation could utilize historical rates of return from a typical QDIA fund, years to retirement,

current contribution levels, and current quotes for lifetime annuity rates with a refund provision to

provide for such a standardized estimate to be included in each regular participant statement.

Entities, such as the PBGC currently survey the insurance industry for annuity rates, and it would not be a

significant additional burden for such entities to similarly survey and publish the results of rates for

immediate annuities with refund options for use in such calculations.

Standard calculators could utilize these assumptions as defaults from which more sophisticated

employees could easily determine the effect of changes to contribution levels and other assumptions

they might like to make.

This would facilitate more ready comparison and at least one form of regular visibility as to the potential

for the current contribution decisions of the participant to potentially realize different income levels after

retirement.

A further paper at the Conference suggested the presentation of not just one such number, but a range

of numbers based on different retirement ages both in front of and following age 65. Yet another paper

of interest at the Conference suggested a means for adding a contributions glide path tracker that might

further be able to signal the need for additional contributions in order to achieve pre‐defined desired

benefit targets.

Both of these later papers demonstrated effective additional improvements on the concept; however,

even without them, there was very broad consensus at the Conference as to the merits of adding at least

some form of basic reporting on the potential for realizing various income levels post retirement that

would be standardized and would be easy to understand and to use for a wide range of plan participants.

   
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Comment 4: The merits of developing a Qualified Lifetime Income Alternative (QLIA) standard

The final theme that was echoed at the Conference was that there remains as wide a variety of options,

though differently directed, for DC plan participants once they reach retirement, as there were for those

participants when they were working and still in their accumulation phase.  The benefits of the

development of the QDIA regulations for accumulation phase activities have been widely recognized.  

There was discussion at the Conference about the merits of having a similar set of regulations that might

define a similar subset of options for the decumulation, or income, phase.   Because of their likely

similarity to the regulations that went into QDIAs, this related set of potential regulations was referred to

as QLIA, standing for Qualified Lifetime Income Alternative.

Like with QDIAs, the basic principle for QLIAs is that they are not intended to restrict retirement phase

participants from finding income generating instruments, asset allocations, distribution levels, advisors

and rules that best suited their particular circumstance.

Likewise, it was evident that the range of options currently available to participants in retirement

matches the range that was available during that participant’s accumulation phase years, ranging from

emerging markets stock funds to annuities, and that that choice should be retained.  Yet, there was no

QDIA‐like way to differentiate the retirement phase options or their suitability as a mainstream choice for

providing for retirement phase income.  Whether assets were held in an IRA or a variable annuity, there

was still a wide range of potential for year to year changes in retirement phase income in the currently

available set of retirement phase options.  A means of differentiation seems clearly needed.

One point of commonality for the QLIA with the existing QDIA regulations was that the inherent

standards for continued diversification and professional management would equally need to apply.  

There are two additional criteria that were discussed that might further distinguish QLIA alternatives:

1) That the alternative must contain some form of longevity protection.  These came in the form of

immediate life annuities as well as in the form of late stage, deferred life annuities combined

with a managed fund paying out in between retirement and the start of the deferred annuity

start date.  For this latter variant, sometimes referred to as “longevity insurance,” a retirement

date of age 65 and a deferred annuity start date of age 85 was often a representative illustration.

2) That the potential for the payout stream ‐‐ whether generated by an immediate annuity or by a

managed fund either in a continued 401(k), an IRA or a variable annuity combined with longevity

insurance – must have a definably low potential to vary from year to year or to become

exhausted or become significantly mismatched before any combined longevity insurance became

active.  Immediate life annuities with a refund provision would clearly meet this standard,

however, there was little to differentiate any of the fund based options combined with a suitable

form of longevity insurance that might also be able to qualify.

Using these two criteria, like with the QDIA, a QLIA would define some limitations on the lifetime income

alternatives that were being offered while still providing (i) for a range of innovations to still be

developed and (ii) for retirement investors to choose other alternatives that might be better suited to

their circumstance.   
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Conclusion:

Amongst the many papers and related topics discussed at the recent Society of Actuaries conference, the

four comment areas discussed above seemed particularly relevant to the Department of Labor’s recent

inquiry about income options for beneficiaries in retirement plans.  These four areas seemed to be of

particular utility since all address significant identified and current shortcomings of the current Defined

Contribution system while not requiring significant departures from regulatory, payment or

administrative infrastructure, or institutional arrangements that have already been developed or are

already largely in place.

The opinions and observations expressed above are solely those of the author and do not reflect the

opinions of the Society of Actuaries, of any of the other presenters or commentators or any other

participant in the Conference.  They are offered as a compilation of observations made by this author

while in attendance at the Conference.

James Gerber, participant