The world of retirement savings recently reached a significant milestone that has important implications for workers and retirees: For the first time, assets in defined-contribution savings plans represent more than 50% of all retirement plan assets globally, according to Willis Towers Watson.
While some defined-benefit pension plans still exist, many more workers today have to rely on defined-contribution plans (think: 401(k) and IRA accounts) to fund their retirements. With today’s defined-contribution plans, workers have to assume the responsibility for making all the complex savings and investment decisions that will significantly affect the amount of money they will have available once they stop working and retire.
While recent innovations in defined-contribution retirement plans, such as the use of auto-enrollment, are making it easier to save, the focus now must shift toward a more-comprehensive approach to help individuals make those savings last.
Increasingly, workers expect their retirement plans to not only help them save, but also help them to generate and manage income through retirement. A recent report by the Georgetown University Center for Retirement Initiatives, “Generating and Protecting Retirement Income in Defined Contribution Plans”, looks at how different approaches can meet individual goals for doing just that.
Planning for income, not just savings
Effective retirement income planning requires complex analysis and careful decision-making. For many individuals, the process can be overwhelming. It is no longer sufficient to ask simply “how much is enough?” when planning for retirement. Instead, the same — or greater — effort has to be put into understanding how savings will translate into monthly income, whether this will meet retirement goals and objectives, and how to avoid running out of money too soon.
As retirees place greater importance on generating retirement income, they have a variety of objectives that they may want to meet. Each individual will have personal preferences and life circumstances to consider, but the income goals often include some combination of stability, maximization, longevity protection, growth potential, cost, and liquidity. The precise mix of these factors will vary significantly from one individual to another.
One size does not fit all
To better understand how different retirement income options perform, the Georgetown Center for Retirement Initiatives (CRI) worked with Willis Towers Watson to analyze a range of income solutions, such as an immediate annuity, a target-date fund using a systematic withdrawal plan or a deferred annuity, as well as other options. CRI examined each of these solutions based on how a sample savings account at retirement would generate and protect annual income, preserve some or all of the starting account balance, and affect the risk of running out of income at any point during a 30-year retirement horizon.
The research makes clear that there is no perfect, one-size-fits-all approach for providing a stream of income in retirement. Different approaches can be used to address different retiree concerns and needs, and they all have trade-offs to consider. For example, if you are risk-averse, it may mean you would trade market growth potential and ready access to your assets — i.e., liquidity —for income stability. What works for one retiree may not be optimal for another, based on the range of considerations involved in such decisions.
“Every individual has unique challenges and goals for their postwork years. Family circumstances, lifestyle expectations, health concerns, and other factors all combine to define personal retirement income requirements,” said David O’Meara, Head of DC strategy at Willis Towers Watson.
Retirement plans must start not to meet future needs
Retirement plans must shift from simply managing account balances to helping individuals think about not only when they plan to retire but also how much income they will need in retirement. This shift in focus will help workers make smarter savings and investment decisions. Although this need seems to be obvious, plans have been slow to provide lifetime income solutions. Plan sponsors can do much more, but they are often hesitant to adopt innovative lifetime income solutions because they fear being sued.
Policy makers can address these concerns and help pave the way for the next generation of retirement plans. Bipartisan support exists in Congress for several proposals that would provide greater flexibility and allow for innovation in the design of lifetime income solutions. The easier policy makers make it for plan sponsors to offer these options, the greater the likelihood that more employers will adopt them.
Plan sponsors do not need to wait for government action. They can start now by demanding and evaluating new solutions, and begin to incorporate them into their plans. Some companies have already implemented solutions; some by developing defaults with income solutions integrated and others that offer a suite of products that provide choices for workers. Individuals can and should have access to the best available lifetime income solutions — along with proper education and assistance to make the right lifetime income decisions based on their own goals and circumstances.
Avoiding ‘retirement roulette’
Without more and better lifetime income choices, retirees are essentially gambling with their retirement savings. Too few have the tools and information needed to manage their nest eggs to last throughout their golden years.
The recent report by the Georgetown Center for Retirement Initiatives shows that options already exist for plan sponsors to help make sure that planning for retirement isn’t a needlessly risky game of “retirement roulette” with workers left on their own to make the wrong decisions and potentially outliving their savings.
Policy makers and plan sponsors must take action now to create the retirement plans of the future that empower workers to save and then convert their pots of money into sustainable streams of income that last throughout retirement.