The Institutional Retirement Income Council, a nonprofit think tank for the institutional retirement industry, has published information to help defined contribution plan sponsors provide retirees and workers nearing retirement with a financially secure retirement.
IRIC highlights six major risks that both retirees and employees nearing retirement face in retirement and offers measures that employers can take to help their workforce and retirees mitigate those risks.
The report found that how plan sponsors approach the topic of retirement savings can have a major impact on how their plan participants approach retirement.
“We hope plan sponsors opt to focus on participant retirement income adequacy, rather than simply investment returns, savings rates and participant rates,” said Rod Bare, an IRIC advisor and co-author of the issue brief. “While those metrics are part of what makes a DC plan successful, DC plans are now a primary source of retirement income for millions of American workers, and so the objective needs to expand. Employers who understand this can act accordingly, in the best interest of their plan participants.”
“Quantifying Key Risks in Retirement” looks at sequential, inflation, longevity, interest rate, health care and behavioral risk.
- Sequential risk: A retiree heavily invested in equities at retirement is exposed to excessive risk. Plan sponsors can help mitigate sequential risk by encouraging participants to invest more conservatively during the years approaching retirement. This can be accomplished through offering education, asset allocation solutions, or guaranteed retirement income products that provide downside protection in the form of lifetime income.
- Longevity risk: Plan sponsors can help participants address longevity risk – the risk of living well beyond one’s life expectancy in retirement – by offering participants an immediate or deferred life annuity, thus providing a steady flow of income for life.
- Inflation risk comes into play when price increases eat away at one’s standard of living, the report said. To mitigate that risk, plan sponsors can offer retirement participants the option to take automated systematic withdrawals with a cost-of-living-adjustment or to purchase an annuity with a COLA.
- Interest rate risk is the possibility of encountering low bond returns and high annuity prices. Low interest rates depress the coupons paid out by bonds, and if interest rates rise, the market value of the bonds will decline. Low interest rates usually lead to an increase in the price of annuities, or an investor receiving a lower payout for the same amount of principal. Giving participants the option to invest in a short-term bond portfolio may be the best way to help them avoid locking in low interest rates for the long term, the report found. In terms of purchasing an annuity, dollar-cost-averaging into an annuity prior to retirement, or holding long-duration bonds that closely track annuity prices, can mitigate interest rate risk.
- Unexpected health care expenses is another major risk in retirement. Plan sponsors can offer access to institutionally priced long-term care insurance with education. Improving employee health and wellness is becoming increasingly important to many organizations.
- Behavioral risk is the possibility of human biases getting in the way of sound decision-making about retirement. Retirees could spend their retirement portfolio too quickly or not consider annuity options, the report stated. Plan sponsors could mitigate this risk by putting participants on auto-pilot by offering a default investment option that helps protect participants from themselves by combining liquid assets and retirement income-oriented insurance products.
“DC plan sponsors can be a valuable resource for their plan participants who are near retirement and can have a positive impact on their employee’s retirement outcomes. With a better understanding of these risks, plan sponsors will be in a much stronger position to help their workers nearing retirement. Many of these risks are interrelated and there will be some trade-offs to consider in addressing each risk. We hope, however, that sponsors take advantage of these suggestions to improve their participants’ outlook for retirement. After all, the goal of the DC plan is not just accumulation – it is increasingly being understood as the delivery of post-retirement income,” said Bare.
The Institutional Retirement Income Council is a nonprofit, membership-based organization of industry advisors who are dedicated to sharing best practices, informing about legislative and regulatory issues, and facilitating solutions for plan sponsors and their participants.