Defined contribution plan sponsors that take pains to secure competitive institutional pricing for their retirement plans investment services to maximize retirement savings for their active employees may also have an incentive to do so for retirees. This issue isnt always the focus of employer attention, however.
Employees who retire and roll some or all of their DC plan assets into retirement income generators purchased on a retail basis will end up with far less than if those RIGs had been secured via the employer, and institutionally priced. Conversely, retirees who have the benefit of lower institutional pricing come out way ahead.
How much? As much as 20%, according to a recent analysis conducted jointly by the Stanford Center on Longevity and the Society of Actuaries. The analysis focused on three RIGs: systematic DC plan withdrawals, single premium immediate annuities, and guaranteed lifetime withdrawal benefits.
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In a nutshell, giving retirees the benefit of institutional pricing involves either persuading them to keep their retirement savings in the DC plan for purposes of a systematic withdrawal strategy, or enabling them to purchase insured products (e.g., the SPIAs and GLWBs) offered through an arrangement with the employer.
Heres a closer look at the numbers, as summarized by Steve Vernon, president of Rest-of-Life Communications. Vernon is also a research scholar at the SCL and a Fellow in the SOA.
100 basis-point spread
The study assumes a 100-basis-point spread between annual asset-based charges among retail and institutional investment products. Specifically, it assumes a 50-basis-point charge for institutionally priced investments, and 150 bps for retail. Clearly, you can have lower cost funds, Vernon says. The most relevant assumption is the 100 [basis-point] spread.
A lower spread would proportionally reduce the ultimate difference in retirement income or residual retirement savings, Vernon adds.
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When examining the systematic withdrawal RIG model, the SCL/SOA analysis looked at two variations. The first is the 4% rule, in which retirees in their first year of retirement with draw 4% of their retirement savings, and adjust withdrawals in subsequent years based on inflation rates. The general goal of this approach is to avoid exhausting retirement savings, but nevertheless risk that possibility if market conditions and/or an unusually long life span make that happen. The institutionally priced advantage for this method: savings lasting two to three years longer.
The other systematic withdrawal method analyzed is the 4% endowment method. Under that more conservative approach, annual withdrawals are limited to 4% of retirement assets, regardless of inflation. This means the dollar amount of annual withdrawals would be reduced if the asset pool shrinks due either to adverse market conditions and the impact of the prior years withdrawal.
Conversely, however, the dollar amount can rise if the 4% is based on an asset pool that has grown since the prior years 4% calculation. Estimated institutional advantage: After 10 years, the retirement paycheck would be 10% higher, and 21% higher after 20 years.
Competitive bidding
The institutional advantage for SPIAs can come from two sources: Lower transaction costs (e.g., embedded sales commissions), and the establishment of a competitive bidding system, in which annuity providers bid for retirees business. (That mechanism is only viable when annuity issuers are incentivized by the prospect of attracting lots of business from the employers stream of retiring workers.)
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The competitive bidding mechanism alone can result in 10%-20% higher income, according to the SCL/SOA analysis, and the reduction in transaction costs can boost retirement income by another 4%-8%. The analysis also determined that a similar substantial advantage could be achieved via institutional pricing on GLWB contracts.
Vernon acknowledges that making it possible for retirees to gain these superior benefits comes at a cost: DC plan sponsors will need to spend the time to conduct the due diligence required to design a program of retirement income, then select and monitor the appropriate products and services.
Why should they bother? One answer is simply that they would be motivated by the same reasons they created an attractive and efficient retirement plan for active employees in the first place, which can include concern for their long-term well-being.
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He also suggested a more practical consideration. The prospect of their employer considering their best interest even after retirement will likely improve their retirement confidence and readiness.
Richard Stolz is a freelance writer based in Rockville, Maryland.
