Turning working folks into professional investors has been a challenge for the asset management industry in the U.S. for nearly three decades. Trillions of dollars and 23 million defined contribution investors later, progress has clearly been made. Now comes the next challenge: decumulation. The term of art coined for postretirement annuitized payouts that mimic Social Security and traditional pensions has been proving even more challenging than accumulation, says Mark Warshawsky, Washington-based head of retirement research for consulting firm Towers Watson. For one thing, he explains, there are a lot of moving parts and more confusion.
“There are ideas out there and the beginning of the process,” Warshawsky adds. “I think that there will be a lot of products.”
High cost is a major obstacle in selling annuities. Products that address pretty much everything people want — a minimum monthly payment, a fund balance, income flow and the ability to grow with the stock market — can cost close to 350 basis points a year. That’s a hefty fee for most defined contribution participants, and employers have not been signing on.
Another problem has been the lack of a clear regulatory nod. Last year the U.S. Internal Revenue Service and the Department of Labor’s Employee Benefits Security Administration requested information from the public on these products and held two days of hearings. The findings were inconclusive, but that has not stopped the asset management industry from continuing to build products in anticipation of plan sponsors signing on.
“I think an annuity is something people can’t afford not to do,” says Kristi Mitchem, head of defined contribution at State Street Global Advisors.
Consultants look at the postretirement asset chase with more of a jaundiced eye. “The industry is all about how do you get the money when they [participants] terminate,” says Pamela Hess, director of retirement research at consulting group Aon Hewitt in Lincolnshire, Illinois. Currently, rolling over participant assets to retail platforms at retirement has been very profitable for recordkeepers like Fidelity Investments and Vanguard Group that started providing bundled plan packages in the 1990s. That has been the default retirement solution pending a new way of distributing participants’ assets.
“There’s a strong argument for putting some portion of personal savings into an annuity for basic requirements,” says Alicia Munnell, Peter F. Drucker Professor of Management Sciences at Boston College’s Carroll School of Management. “Social Security is special,” she continues. “We’re losing a particular type of retirement income.” Munnell, who also directs the college’s Center for Retirement Research, adds, “We’ve been used to having some annuitized income through Social Security.”
But building annuitized products will not be a cakewalk. The insurance industry owns the franchise on guaranteed lifetime income, explains Thomas Streiff, retirement product manager at Pacific Investment Management Co. When the asset management and insurance industries work together, there are challenges with both delivery and education. Pimco has partnered with MetLife to offer an annuity product tied to one of its mutual funds that is only being offered on the retail level, not through workplace retirement plans. “We’ve made progress, but not enough,” Streiff complains.
There are several practical concerns about the benefits of annuity products. Dean Takahashi, senior director of investments at the Yale University Investments Office, has started to look at the retirement issue on behalf of the university’s professors and others. Takahashi, who has worked alongside endowment head David Swensen for 25 years, believes future retirees face a number of challenges.
“It is difficult to find simple, straightforward advice on how much people need to save,” Takahashi explains. “And once they have retired, they get little guidance on how much of their savings they can draw each year as they budget their resources over an uncertain life span. Life annuities can help deal with the risk of outliving one’s savings; however, annuities usually don’t address inflation risk.”
The Yale investments director says many retirees avoid annuities because their terms and pricing are difficult to understand. They also worry about losing their money, leaving less for their heirs, if they die soon after retiring.
Asset managers’ awareness of these pitfalls and their eagerness to make sales are driving new-product research and development. At BlackRock’s San Francisco offices, home to the former Barclays Global Investors team that created the first target date fund in 1993, Chip Castille, head of the U.S. and Canadian defined contribution group, explains the firm’s next-generation product. Advances in technology have enabled BlackRock, which bought BGI in 2009 and manages $325 billion in defined contribution assets in North America, to create a new series of target date funds that replace the fixed-income portion of these multifund portfolios with an annuity. A separate account with MetLife and interest rate averaging allow the funds to charge about half of what a typical guaranteed minimum withdrawal benefit wrapped around a target date fund would cost.
AllianceBernstein Investments has advanced the cause by bundling multiple insurers in its guaranteed withdrawal benefit. The company delivers the annuity inside a target date fund structure for one third the price of a stand-alone annuity. It begins phasing in at age 50 and is fully established within the participants’ accounts by age 60. “Portability is key,” says Thomas Fontaine, head of defined contribution investments. “It had to be able to change insurers and recordkeepers and preserve the benefit.” But David Bauer, a partner with Casey, Quirk & Associates, cautions, “There isn’t enough balance sheet in all the insurance companies in the country to annuitize everyone’s retirement income.”
For those who want a distribution vehicle without an insurance component, Fidelity offers a series of income replacement funds that work as a sort of reverse target date fund. Investors select the date they want their fund to liquidate, and the fund pays out until that date. According to Fidelity, annuity products have not been widely used because many people do not want to confront their own mortality.