Many Americans today can expect to spend 20 years or more in retirement, but for some, increased longevity may bring added uncertainty about their financial futures.
According to TIAA data, a couple at age 65 has an 89% chance of one of them living to 85, a 73% chance to reach 90, and a 49% chance to hit 95. Yet as life expectancies — and years spent in retirement — have increased, the availability of defined benefit (DB) pension plans has generally waned. Many American workers may no longer have access to these plans, which were created around the principle of providing a guaranteed income stream for life.
Rather, many workers generally rely now on defined contribution 401(k) plans, which were originally developed to supplement defined benefit plans and focus on asset accumulation instead of generating lifetime income. That means workers today are faced with the daunting task of stretching the lump sum of retirement assets they’ve accumulated during their working years throughout their entire retirement.
And no matter how prudent these people are at creating a systematic withdrawal strategy, they are still at the mercy of market fluctuations. Our research shows that if retirees make withdrawals from their retirement savings that are equal to the income payments they would receive from a lifetime annuity (assuming the same interest rate), there is a greater than 50% chance that the retiree will outlive his or her savings.
However, there is a defined-contribution model that focuses on retirement income: the 403(b) plan.
How 403(b) Plans Differ
Over time, 401(k) plans have become the primary retirement savings mechanism for many workers. However, they heavily consist of mutual funds and other options that are not intended to generate retirement income, reflect this. Additionally, these plans historically offered limited resources to support employee financial well-being past retirement, although that has been changing in recent years.
But unlike 401(k) plans, 403(b) plans originally were designed as core retirement plans for nonprofit organizations, with a focus on generating lifetime income. Investment menus for 403(b) plans commonly feature income options — such as low-cost, in-plan fixed annuities, which can provide a guaranteed benefit that never goes down and serve to manage risk in employee’ overall portfolios.
These plans may also focus on providing ongoing communication to employees and retirees — helping to maintain employee engagement and success to and throughout retirement.
Five Characteristics of Well-Designed DC plans
Both 401(k) and 403(b) plans are important to the financial well-being of American workers, and they can learn from each other. While 403(b) plans have adopted many 401(k) operational and design practices, 401(k) plans can look at the success of 403(b) plans in providing lifetime income to help employees improve their retirement security.
A properly designed defined contribution plan can provide a retiree with an income stream for life. We’ve identified five characteristics of a well-designed plan that, we believe, can help participants pursue lifetime income:
- Encourage adequate income replacement. A defined contribution retirement plan should aim to replace an adequate portion of workers’ pre-retirement incomes — typically between 70% and 90%, including Social Security and other savings — to help provide lifetime income throughout retirement.
- Focus on income in retirement. To create a successful defined contribution plan, plan sponsors should build the plan structure, features, and services around the goal of lifetime income.
- Include guaranteed income products. By offering low-cost, in-plan annuities on their investment menus or out-of-plan annuities available when employees retire, defined contribution plans can help participants generate retirement income they cannot outlive. We have found that when employees contribute to an annuity over time, they can receive 20%-plus more income in retirement than if they purchased it with one lump sum at the end of their employment.
- Offer diversified investment menus. Defined contribution plans should include diversified investment options for participants and offer a Qualified Default Investment Alternative (QDIA) for workers automatically enrolled in the plan. This helps engage all employees in saving for the future.
- Maximize participation. After designing an effective defined contribution plan, it is important to encourage all employees to take advantage of the resource. Plan sponsors may want to consider the following steps to help participants save enough to generate sufficient income in retirement:
- Use automatic features and employer-match design strategies to help increase participation and savings rates.
- Safeguard plan assets — for instance, by limiting loans — to limit the premature withdrawal of assets.
- Offer the education, advice, guidance, and tools that employees may need to help reach their retirement income goals and create an employee engagement strategy that empowers employees to take an active role in planning their financial futures.
An important component of any successful retirement plan remains effective and engaging communication with participants. This means employers need to look beyond the one-size-fits-all approach to employee engagement and offer different strategies based on employee demographics and needs.
Plan sponsors may want to reframe their participant statements to provide employees with information that translates their retirement plan savings into expected income in retirement — not accumulated wealth.
Personalized advice and education services can go a long way in helping employees make both broad retirement planning decisions as well as individual investment selections. As an example, fees and expenses are always an important consideration, but many plan participants don’t know how annuities are priced, or that many in-plan annuities may be cheaper than retail annuities.
The fact is that employees generally look toward their employers to help them reach a secure retirement. In fact, our research found that 81% of workers trust the information provided by employers.
By taking a lesson from 403(b) plans and the success of retirement outcomes in the nonprofit market, corporate plan sponsors can design define contribution plans that emulate the security of defined benefit plans to provide lifetime income for plan participants.
Tim Walsh is the managing director for institutional investment product distribution at TIAA.
 TIAA Actuarial (based on 2014 TIAA dividend mortality)
TIAA Institute: TRENDS AND ISSUES (10/06). The payout annuity assumes a 65-year-old retiree, single-life annuity with 10 years guaranteed, 4 percent rate of return, and the mortality assumptions used in computing current total income under TIAA or CREF payout annuities.
 Guarantees are subject to the claims paying ability of the issuing company.
 TIAA Actuarial, as of 1/1/16, someone who was in TIAA Traditional for 30 years and amassed $100,000 through level monthly contributions would receive annual income of $7802 (Age 65, Single Life Annuity with 10 years guaranteed), which is 27 percent more than someone transferring $100,000 to TIAA Traditional the day before retirement. . Based upon TIAA proprietary research.
 TIAA-CREF 2014 Investment Options Survey
TIAA-CREF Individual & Institutional Services, LLC, Teachers Personal Investors Services, Inc., and Nuveen Securities, LLC, Members FINRA and SIPC, distribute securities products.
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