Retirement Income Solutions - In-Plan or Out-of-Plan?

Very recently, we had a paper published in the Journal of Compensation and Benefits.  Dr. Greg Kasten is the primary author, and I had a small contribution to it.  You will find it linked here: 

https://www.unifiedtrust.com/documents/RetirementIncome-InPlan-vs-OutOfPlanSolutions.pdf

The paper deals with the recent trend of offering guaranteed income products, often in the form of a Guaranteed Income for Life Annuity, inside of 401(k) Plans.  The purpose of the article was to explore if real demand existed for such products and if so, were they better placed inside of a qualified retirement plan or outside of one?

Summary of findings:  Guaranteed Income for retirement, simply put, is a good idea.  However, the current availability of these products within the 401(k) space is poor.  The products are at an immature stage in their life cycle and are problematic for a variety of reasons.  Thus it would be advisable for a client to seek guaranteed income outside of their 401(k).  

Going a little deeper:

1.) Retirement Income Products are desired to provide a regular guaranteed stream of income.

2.) Many 401(k) service providers are putting these types of products into their 401(k) plan products.

3.) Question: Will employers and participants be better served with these products in a 401(k) Plan or outside of it, post retirement or in an IRA?

4.) Concerns for In-Plan Solutions:

a. Fiduciary Prudence – Is it a good idea for an employer to endorse an income product by putting in a plan as a Designated Investment Alternative?

  i.     Time and resources required to satisfy regulatory requirements for specialized products
  ii.    Lack of benchmarking and monitoring guidance for new products
  iii.   Risk of fiduciary liability for failing to meet participant expectations
        
b.      Product Feature Issues:
 i.      In order for the participant to receive the full value of the Income Product – They must be held  to term.  In many cases, early withdrawal or cancellation can be excessively wasteful.

 ii.      Diversification Issue – Currently, the insurance carrier who supplies the Income Product typically will only offer one Income product, their own.  They will not allow fair competition for the employee to select the one that’s best for them.  It is like offering a 401(k) plan with one balanced mutual fund and a money market fund and saying if they want access to the market, they can invest in the balanced fund.  What if the balanced fund isn't appropriate for that participant?
                     
 iii.     Portability – In order for employers to exercise their fiduciary duty, they must periodically check the marketplace to ensure that what they have is still in the best interest of the participants.  Over the lifetime of a plan, it is likely that a service provider change will occur, typically every 5-8 years on average.  At present, these Income Products are not portable.  This presents a practical issue for the employer.

 Do they make a provider change and force the participant to sell their Annuity early and take a large loss?  If yes, that’s a big fiduciary risk.

 If no, do they operate the plan with multiple service providers, requiring coordination between vendors, excess fees to administer, etc.?

 Do they not make a change to avoid options 1 and 2?  This is akin to being held hostage by a bad investment arrangement.

 iv.     Rollover ability – If participants change jobs, these products can’t be rolled to another employer’s plan, and perhaps not even into an IRA.  For people who change jobs periodically, this presents another practical issue.  What does the participant do in the event of a job change?

 v.     Fee transparency and reasonableness – Because these are individual annuities, the benefit of pricing power from asset aggregation is lost.  As a result, these annuities are often expensive and opaque in nature.  Further due to what is listed above, they would fail the DOL’s definition of a fair or reasonable contract or arrangement.  Specifically, the DOL views a reasonable contract or arrangement as one that is explicit in fees,
written and that can be terminated in a reasonable time frame without fee or penalty.  These currently do not meet that standard.

 vi.    Survivorship -  Most of the current versions of these Income for Life annuities are participant only, meaning that they don’t extend benefits to the surviving spouse in the event of death.  Compared to income products that exist in the open market, this is a very big disadvantage.

5.) Based on the above, the advice is that Income for Life products are a good idea, but are immature in their product life cycle.  Guaranteed Income can be found elsewhere, i.e outside the 401(k) plan, with more advantageous features and benefits.  Until the next generations of these are created, it would be inadvisable to put them into a 401(k) Plan.