How the promise of lifetime income encourages retirement savings
Prudential Retirement, a unit of Prudential Financial, serves more than four million retirement plan participants and annuitants, representing $375 billion in assets. EBN recently spoke to Jamie Kalamarides, leader of Prudential Retirement’s Full Service Solutions business, about issues in meeting the needs of plan participants and the role of guaranteed income products. Kalamarides oversees Prudential Retirement’s recordkeeping, administration and investment services. Highlights of that conversation follow.
Employee Benefit News: What’s foremost on your plan sponsor clients’ minds today?
Kalamarides: I think plan sponsors have three major topics that they’re dealing with. The first one is they’re trying to make sense of the fiduciary role and their obligations underneath it. The second one is if they have a defined benefit plan, risk transfer and the issues involved in a low-interest rate environment. Third, they’re thinking about the broad topic of the financial wellness of their employees, and how help employees achieve it.
EBN: How do you define financial wellness?
Kalamarides: First, it’s the ability to manage one’s day-to-day expenses relative to one’s income. Second, [it’s] being prepared for unexpected bumps in the road, with emergency savings and insurance. And third, [it’s] saving sufficiently toward long-term financial security.
EBN: Prudential’s message to plan sponsors and others is that you are “changing the way Americans save for retirement.” What does that mean?
Kalamarides: It begins with the understanding that in order to save for retirement, you need to have control over day-to-day expenses, understand the tradeoffs between how you spend money today versus what you’ll have tomorrow, and having all the tools and influencing the behaviors around saving for tomorrow. So it’s the focus on financial wellness that is a key part of what we are trying to do in helping people save for retirement. We can help people on the retirement accumulation side, but as an insurance company we are also positioned to help people manage risks around disability and [premature death]. Also, we can help people know their retirement income will last with guaranteed lifetime income products like IncomeFlex.
EBN: How do you help employees really grasp the tradeoffs involved in retirement savings decisions?
Kalamarides: One part of it is sharing and applying the results of behavioral finance research. We help individuals to understand why their brain may be to blame for some of their behaviors, and we help reframe issues and problems so that they can overcome the inertia, hindrances or risk aversion that is inside us, and how to use that to one’s advantage.
EBN: Could you illustrate?
Kalamarides: Yes. Recognizing the power of inertia, we require plan participants to opt out, as opposed to opt in — auto-enrollment, and auto-escalation as opposed to having to manually go and increase your savings every year. We do automatic asset rebalancing, which is very important for participants to maintain an appropriately diversified retirement portfolio.
With respect to the trade-offs, for many younger employees the question is how aggressively to pay off student debt as opposed to save for retirement. We are a major investor in a firm called Student Loan Genius, and are deploying it out to workplaces. Student Loan Genius gives individuals an opportunity to consolidate loans, and by working with brokers, find the best way to balance those obligations by projecting the impact of varying debt reduction and retirement scenarios, showing the impact of employer matches in the 401(k), and so forth.
EBN: Do you encounter reluctance to auto-enrollment and especially auto-deferral rate increases from employers who worry about plan costs?
Kalamarides: We do get some of that, but we’ve created a modeling tool that projects for employers the impact of different auto-enrollment and auto-escalation scenarios. So, for example, instead of matching 50% on the first 6%, why not match 25% on the first 12%? The result might be less expensive for the employer, but still incentivize employees to stretch.
The modeling also gets into the situation of employees who want to retire not being able to afford to do so. This can lead to a discussion about lifetime income products, which can increase employee confidence of their ability to have a sufficient income throughout their retirement. People don’t think about a large number, several hundred thousand dollars or a million dollars, they think about, “Can I cover these monthly expenses, my rent, my food, my utilities, my medicine?”
EBN: Can you give an update on the evolution of IncomeFlex?
Kalamarides: When we originally rolled it out it in 2007 it was called IncomeFlex Select, and that product is no longer offered for new sales. More recently we have rolled out IncomeFlex Target, a guaranteed lifetime withdrawal benefit, GLWB, around target date funds. If an employer had that target date fund as a QDIA, they could simply put this onto the plan as well and it would still remain a QDIA. The most interesting development that’s happened since then is the ability of a plan sponsor to move the investments to another recordkeeper if for some reason they want to make a change.
EBN: Many plan sponsors have been concerned about the duration of their liability when they incorporate a lifetime income product into their 401(k)s. Any relief in sight?
Kalamarides: We think that will be addressed by the Retirement Enhancement and Savings Act, which cleared some hurdles in the last Congress. It has a fiduciary safe harbor for the selection of a lifetime income provider, and provides that if a plan sponsor decides not to offer a guarantee product for some reason, that the individual can roll it out of the plan as a qualified distribution and maintain their guarantee. We think these things are going to remove the sort of barriers that have prevented plan sponsors from adopting lifetime income solutions.
EBN: There is no “free lunch,” in that there is a cost to the guarantee inherent in a GLWB or annuity contract, right?
Kalamarides: There are three different forms of lifetime income, one is not guaranteed. That one is the systematic withdrawal or a managed account. Those say “we’re going to charge you a managed account fee use ‘best efforts’ to maintain the portfolio, but if you run out of money, we tried our best.” The more traditional way of people thinking about lifetime income is fixed annuities. And a fixed annuity says you turn over your principal to the financial institution and they provide a percentage of that for your life. And you can cover your spouse as well.
With a fixed annuity, the cost is dependent on the spot interest rate environment, and an annuitization table. And while you can compare rates at the point in time, you can’t compare rates over time, and also you don’t get any upside benefit. If you buy it very early in your life, you’re not accumulating the benefits of market growth.
EBN: And the third type?
Kalamarides: It’s the GLWBs, guaranteed lifetime withdrawal benefit products, and they have an explicit cost. They go around a target date fund. The target date fund’s expense ratio is the exact same expense ratio that you would pay if you were in the target date fund alone. Say it’s 50 basis points. Then there is an explicit risk fee that is the guarantee fee. And in IncomeFlex’s situation, it’s most often 1%. And the earliest you can turn the guarantee on is 10 years before retirement. You can also turn it on at retirement. So it is explicit, it is disclosed, we don’t charge people early for it, and it provides real guarantees.
EBN: Is there evidence that if plan participants know that ultimately they’ll have a lifetime income guarantee at retirement, they will save more aggressively?
Kalamarides: Yes. Across both Aon Hewitt’s and our own research, when a lifetime income solution like IncomeFlex is available in the plan, individuals contribute 10.1% of their savings versus 7.3% if it’s not available. Not only that, they’re happier with the plan, and behave rationally and stay the course on their diversified investments during volatile times.
EBN: How would you compare a fixed annuity to a GLWB product when interest rates are low like today?
Kalamarides: In a low interest rate environment, traditional fixed annuities seem relatively expensive compared to other times. And the risk is if you want to buy a traditional fixed annuity, a single premium annuity, or deferred annuity, you’re buying it in today’s spot interest rate environment. You could wait, but an individual is then taking risks about market timing and when interest rates will actually increase. And when they do increase, will individuals say, “Well maybe I should wait another six months to buy another fixed annuity.” GLWBs take the uncertainty out of that. The benefit of a GLWB is that you’re staying invested in the equity markets and in diversified portfolio over time.