The first 401(k) generation
The way Americans think about 401(k) plans, and by extension TDFs, is about to be turned on its head. Traditionally, the success of 401(k) plans has been measured in terms of savings rates and capital growth simply because the baby boomers—the first 401(k) generation—were in their prime years of saving and investing.
Now, amid a growing wave of baby boomer retirements set to crest in 2029, when the last of the boomers reach 65, savings rates and capital growth for many 401(k) participants are quickly becoming concerns of the past. Given the sheer rise in the number of retirees, the most critical issue facing financial advisors, plan sponsors and participants going forward is income—its amount, variability and sustainability all throughout retirement.
Think ‘3 Rs’ – results, reliability and risk
The shift in thinking from what’s needed before retirement to what’s needed after often starts with financial advisors and plan sponsors moving away from “the three F’s”—Funds, Fees and Fiduciary, to the much more relevant “three R’s”—Results, Reliability and Risk:
- Results: How many participants will hit their income goal? For plan sponsors and participants alike, it’s becoming increasingly clear that the primary outcome for a retirement plan is delivering a stream of income to maintain a desired lifestyle in retirement, not in achieving a high account balance.
- Reliability: How reliable is the income projection? With income as the prime outcome, retirement income ranges need to be projected and the probability of achieving these ranges must be disclosed on the statement. The focus here has to be on maximizing the probability of delivering on the income goal.
- Risk: How much risk are participants taking ONE year before retirement? Generating reliable results all begins with managing risks. Chief among those facing retirement is transition risk, which is the risk of transitioning from the accumulation phase of retirement investing to the income phase under unfavorable market conditions.
Back to the future for income
Helping financial advisors deliver on the three R’s is perhaps the most important participant education tool available—the quarterly 401(k) statement. The focus of these statements, for better and for worse, has been to report the amount that a participant has saved and how much was saved, gained or lost in the previous quarter. The account statement, however, is a look into the past without a view into the most important period of time for a retirement investor—the future.
In delivering for the future, 401(k) plans, along with the most popular investment option in those plans—TDFs—would do well to look back at what the retirement plan of the past did so well. The defined benefit pension plan was a model of reliability, providing a stream of income that could be counted on all throughout a participant’s retirement. Going forward, 401(k) plans will have to approximate that type of reliability for Americans to retire successfully.
Amending ERISA for income projections
To their credit, legislators are taking up the cause in a rare bit of bipartisanship on Capitol Hill. Last spring, Representatives Luke Messer (R-IN) and Mark Pocan (D-WI), along with Senators Johnny Isakson (R-GA) and Chris Murphy (D-CT), introduced the Lifetime Income Disclosure Act of 2017. The bill would amend ERISA to mandate annual income projections on all 401(k) statements.
Projecting retirement income is easier said than done, however, so the bill instructs the Department of Labor (DOL) to “issue a model lifetime income disclosure, written in a manner which can be understood by the average participant, and prescribe the assumptions that plan administrators may use in converting total accrued benefits into lifetime income stream equivalents.”
To help matters along, the DOL would also issue tables showing the assumptions used to project income, likely taking into account inflation rates as well and historic average investment returns to project annual income for each participant. Given the potential risk of being too promissory, a safe harbor has also been proposed to insulate plan sponsors from liability if income falls short of projections.
The virtuous cycle of savings and income
Faced with a lump sum of retirement savings and without practical experience about what to do going forward, the first wave of baby boomers to retire found it a bit tricky to translate that sum into an income stream. But now that the baby boomers are fully engaged in all phases of the TDF lifecycle—from saving to wealth accumulation to decumulation—the ability to generate income, as well as the ability to clearly communicate income projections on account statements, is becoming more important than ever.
Such statements would show that income uncertainty, not fluctuating portfolio valuations, should be the most important concern for plan participants. Income projections could also help participants make earlier and better investment decisions, as well as spur them to save even more to keep their retirement goals on track. In the end, the only truly successful outcome for TDFs is, of course, income.
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About the Author
Glenn Dial is Head of Retirement Strategy in the US with Allianz Global Investors, which he joined in 2011. He has more than 25 years of defined contribution experience. Mr. Dial is a co-inventor of the method and system for evaluating target-date funds, and is also credited with developing the target-date fund category system known as “to vs. through.”
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