Retirement Income
FRED REISH, ESQ.
November 6, 2014
The Retirement Dilemma
The concern is twofold:
• Will participants have enough money when they
retire (benefit adequacy)?
• How will participants withdraw their money, so
that they do not exhaust their accounts or IRAs
before they die?
Retirement Income ● November 6, 2014
1
Benefit Adequacy
“Benefit adequacy” means having enough money to
“buy” sufficient income in retirement to maintain a
participant’s desired standard of living, taking into
account:
• Retirement plans and IRAs.
• Other savings and investments.
• Social security retirement income.
Retirement Income ● November 6, 2014
2
Modern Retirement
In 401(a) and 403(b) plans, participants need to decide:
 how much to defer;
 how to invest it; and
 at retirement, how to take out the money.
. . . to generate the retirement income they need.
Retirement Income ● November 6, 2014
3
Successful Plans
While plan sponsors can use a variety of means to
improve benefit adequacy, the most efficient and
effective efforts have been “automatic:”
• Enrollment
• Deferral increases
• QDIA investing
Retirement Income ● November 6, 2014
4
Challenges for Lifetime Income
The following are the principal issues:

Longevity risk.

Inflation risk.

Sequence-of-return risk.

Cognitive risk.

Withdrawal rate risk.
Retirement Income ● November 6, 2014
5
Impact of Longevity
People are living longer:
 If a participant and his spouse are both 65, there
is a 50% chance that one will live to age 92, and
a 25% chance that one will live to age 97.
 Half of today’s 65-year-old men are expected to
live to 85, and half of 65-year-old women are
expected to live to 88.
[“Building Your Future,” Insured Retirement
Institute, 2011.]
Notes: Updated Society of Actuaries tables; education effect.
Retirement Income ● November 6, 2014
6
Demographic Trends
“Wilshire Consulting estimates defined benefit
pension plan liabilities will increase between
3% and 8% in total for most [defined benefit]
plans when they move to new Society of
Actuaries mortality tables.”
Comment: Isn’t it similar for 401(k)/403(b) participants?
PLANSPONSOR.COM, “New Mortality Tables Will Impact Pension
Plan Management,” July 3, 2014.
Retirement Income ● November 6, 2014
7
Long Lives
“To illustrate the unique financial complexities facing
retirees, consider 10 high school friends who decide
to retire at age 65. Now, guess when the first of
those 10 friends will die. As it turns out, the first
death is likely to occur only four years into
retirement, at age 69. Next, try guessing when the
last person will die. The answer is 34 years into
retirement, at age 99!”
Shlomo Benartzi, UCLA Professor
April 2010
Retirement Income ● November 6, 2014
8
Gains in Older Worker Participation in
Service Sector from 1980-2010
Retirement Income ● November 6, 2014
9
Labor Force Participation Rates at Ages
62-64 by Education, 2000 and 2010
Retirement Income ● November 6, 2014
10
Withdrawal Rate Risk
Table 3. Estimated Probability by CRS That A Retirement Account Will Last for at Least a Specific Number of Years
Initial annual drawdown rate
4%
5%
6%
87.8%
77.0
66.9
65.2%
49.5
38.8
Probabilities that money will last a given number of years, excluding the impact of investment fees and taxes
25 years or more
30 years or more
35 years or more
97.7%
94.0
89.4
Source: CRS Monte Carlo simulation of a portfolio consisting of 35 percent S&P 500 index and 65 percent AAA-rated corporate bonds.
But, see “The 4 Percent Rule is Not Safe in a Low-Yield World,” Finke,
Pfau and Blanchett.
Retirement Income ● November 6, 2014
11
The Withdrawal Risk
One recent study showed that more than 33% of those
interviewed had no idea how much they could safely
withdraw and roughly 25% expected to be able to
withdraw more than 10% of their retirement savings
each year.
Given this failure to understand sustainable withdrawal
rates, there is a risk that retirees will exhaust their
savings when they are in their late 70’s or 80’s.
See, Lee Barney, “American All Over the Map on Retirement Drawdown
Rates,” Money Management Executive (October 13, 2011).
Retirement Income ● November 6, 2014
12
Cognitive Abilities
The benefit of a pre-arranged distribution methodology:
While old age may bring more experience and
wisdom, it also diminishes the quality of decision
making.
After age 60, the prevalence of dementia roughly
doubles every five years. by the time people reach
their 80s, more than half will suffer either dementia
or other significant cognitive deficits.
David Laibson, Harvard Professor, Behavioral Finance and the PostRetirement Crisis, sponsored by Allianz of America, April 2010.
Retirement Income ● November 6, 2014
13
Benefit Adequacy
While 403(b) and 401(a) defined contribution plans
typically report account balances to participants, benefit
adequacy is better measured by monthly income in
retirement.
Question: What is needed to help participants view their
account balances as monthly retirement income?
Retirement Income ● November 6, 2014
14
The DOL’s Regulatory Agenda for 2013-14
Pension Benefit Statements:
As part of this initiative, the Department will explore
whether, and how, an individual benefit statement
should and could present a participant’s accrued
benefits in a defined contribution plan (i.e., the
individual’s account balance) as a lifetime income
stream of payments in addition to presenting the
benefits as an account balance.
Retirement Income ● November 6, 2014
15
The DOL and Projections of Retirement
Income
A. Estimated for Current Account
Value
1. Account Value
2. Monthly Income
after Retirement
3. Survivor Monthly
Income
$124,023.02
$459.92
$229.96
$665,715.09
$2,468.67
$1,234.34
B. Projected at Retirement
•
•
All future projections are shown in today’s dollars, which account for inflation. Inflation
changes the purchasing power of money. Presenting your projections in today’s dollars will give
you an idea of how much you could buy with your retirement account when you retire.
Caution: projected values at retirement are only estimates.
Retirement Income ● November 6, 2014
16
Most With Retirement Plan Find DoL Lifetime
Income Calculator Estimates Match Expectations
If you and your employer were to continue contributing at the same percentage of compensation until you retire,
some retirement calculators estimate that your employer‐sponsored plan could provide a monthly retirement
income for life of [estimated amount]. Keep in mind that this does not account for any retirement savings that you
might have outside of your employer‐sponsored plan. Would you say that this amount is… (2014 Workers
contributing to retirement savings plan and provided amount n=223)
Much less than you expected
8%
Somewhat less than you expected
19%
About what you expected
58%
Somewhat more than you expected
7%
Much more than you expected
5%
Source: Employee Benefit Research Institute and Greenwald & Associates, 2014 Retirement Confidence Survey.
Retirement Income ● November 6, 2014
17
Impact on Benefit Adequacy
 Gap analysis:
•
Projects the results of the participants current
behavior—in terms of retirement income.
•
Provides reasonable benchmarks for comparing
those results to typical needs.
•
Provides guidance about how to close the “gap.”
 Seminars for older participants.
Retirement Income ● November 6, 2014
18
Available Products
There are a number of insurance and investment
products in the marketplace that are designed – or at
least intended – to provide lifetime income.
 Insurance: Traditional annuities.
 Insurance: Longevity insurance.
 Securities: Managed payout and retirement income
mutual funds.
 Securities: Managed retirement income accounts.
 Blend: Guaranteed withdrawal benefits (GWB or GMWB).
Retirement Income ● November 6, 2014
19
In-Plan versus Out-of-Plan Options
An issue in the selection of a lifetime income product is
whether to offer the product as:
• An option in the plan (referred to as an “in-plan”
solution);
• A distribution option (transition-from-plan); or
• Neither an in-plan or a distribution solution
(“out-of-plan”).
Retirement Income ● November 6, 2014
20
Retail Cost versus Institutional Cost
Cost:
Retail annuities can be . . . expensive . . . However,
this can be mitigated in institutionally priced annuity
programs.
Note: The issue of institutional pricing extends to all
retirement income “solutions.”
“The growing demand for retirement income solutions: Options for
the plan sponsor,” Wells Fargo, 2010.
Retirement Income ● November 6, 2014
21
Example
In a GWB product, a participant invests in an investment
that includes the GWB guarantee. At retirement, the
participant begins to take withdrawals . . . (either in the
plan or . . . an IRA) at a specified rate (depending on the
retiree’s age and whether the guarantee also covers his
spouse) based on the participant’s “income base.”
If his account runs out, the insurance company
continues to make payments at the same rate.
Retirement Income ● November 6, 2014
22
Fiduciary Considerations
However, there is no obligation under ERISA for 401(k)
plans to provide investments, products or services for
retirement income.
If offered, though, the products, investments or services
must be prudently selected and monitored.
Retirement Income ● November 6, 2014
23
Fiduciary Issues for Retirement Income
Products
 Portability
• Distribution portability
• Platform portability
 Costs
 Status as QDIA
Retirement Income ● November 6, 2014
24
ERISA’s Prudent Process for Insured
Benefits
The DOL’s regulatory “safe harbor” is available to
fiduciaries that engage in the following steps, in addition
to considerations of cost:
• Engage in an objective, thorough and
analytical search for the purpose of identifying
and selecting an insurance company.
• Consider information to assess the ability of the
insurance company to make future guaranteed
payments.
continued . . .
Retirement Income ● November 6, 2014
25
ERISA’s Prudent Process
Continued . . .
• Appropriately conclude that, at the time of the
selection, the insurance company is financially
able to make future payments under the
annuity contract.
• If necessary, consult with a knowledgeable
consultant.
Retirement Income ● November 6, 2014
26
DOL Regulatory Agenda
ISSUE: Making 401(k) benefits last for life
Selection of Annuity Providers—Safe Harbor Individual
Account Plans
“the Department is developing proposed
amendments to the annuity selection safe
harbor”
Note: Complimentary Treasury guidance, e.g., QLACs.
Retirement Income ● November 6, 2014
27
Fiduciary Checklist for Insured Benefits
Key factors to consider:
 Strength and stability.
 State insurance regulation.
 State guarantee associations.
Retirement Income ● November 6, 2014
28
Efficiency of Retirement Money
It is significantly more cost effective for a person to
insure longevity risk through risk pooling (whether
through purchasing an annuity or other lifetime
income guarantee or electing a lifetime income
option in a pension plan) than to bear that risk alone.
In contrast, depending on the method used to “selfinsure,” 50 percent to 75 percent more money would
need to be set aside than if an individual participated
in a risk-pooling arrangement.
American Academy of Actuaries, Letter to EBSA, May 3, 2010.
Retirement Income ● November 6, 2014
29
Retirement Security
Expect developments in:
 Retirement planning services.
 Retirement income products.
 Retirement income services.
Retirement Income ● November 6, 2014
30
FRED REISH, ESQ.
1800 Century Park East, Suite 1500
Los Angeles, CA 90067
(310) 203-4047
(310) 229-1285 [fax]
Fred.Reish@DBR.com
www.linkedin.com/in/fredreish
www.drinkerbiddle.com
FOLLOW FRED ON TWITTER @FREDREISH
CALIFORNIA | DELAWARE | ILLINOIS | NEW JERSEY
NEW YORK | PENNSYLVANIA | WASHINGTON DC | WISCONSIN
© 2008 Drinker Biddle & Reath LLP | All rights reserved.
A Delaware limited liability partnership