Prepare DC plan members for retirement

Sun Life Financial’s most recent Unretirement Index reports that, on average, more than 400,000 Canadians will reach retirement age every year for the next 17 years. This translates to roughly 1,000 baby boomers retiring in Canada each day. But as they approach retirement, market volatility has eroded their confidence that their investments will be enough, even as medical science promises them a longer life. It’s a double-edged sword, and research reveals the extent of the impact. The report also shows that nearly one-quarter (22%) of all Canadians are “not at all confident” that they will be able to pay for their basic living expenses in retirement, while 40% are worried about outliving their retirement savings—and another 40% simply “don’t know or aren’t sure.”

For a DC plan sponsor, retirement income adequacy presents a real dilemma. What role should your capital accumulation plan play in helping plan members to draw income during retirement? Will there be an active retirement income component to your plan? And, more importantly, what can plan sponsors do to help plan members complete their retirement planning cycle?

DC plans have evolved dramatically over the past 20 years—an evolution that has been significantly shaped by the decline in DB plans. As plan sponsors address the question of how far they should go to facilitate retirement income, they also need to acknowledge that, for many, if not most plan members in the private sector, the workplace DC plan is their primary source of retirement savings.

So what can plan sponsors do?

Provide Retirement-readiness Information

One of the most straightforward things a plan sponsor can do is to accommodate members’ age-related needs. Sun Life research shows that the employees who most need to be planning their retirement income options—those age 57 and over—find the information that they receive too confusing. And when people are confused, they’re not taking action.

Plan sponsors can address some of the most basic needs by communicating differently—by acknowledging the many issues around financial literacy (such as market volatility), regardless of age, and by engaging plan members in a way that tries to get them to take positive action. The growing number of older plan members desperately needs more pre-retirement education about income options. Some experts argue that the right thing to do is to maintain an ongoing dialogue with plan members after they have retired.

A more committed approach is to offer advice. Advice can mean simply offering plan members special pre-retirement seminars or paying for one-on-one professional financial planning support. Financially secure people simply make better employees. Those who receive help from their employers to manage their personal investments—no matter what form that help takes—feel more valued, tend to be more engaged and loyal, and are also more likely to become brand ambassadors.

Communication and advice are the big retirement-readiness pieces that speak to the level of support for plan members as they move from the accumulation phase to the de-accumulation phase of their savings cycle. The other side of the equation is providing plan members with income options that start during their saving years and which may or may not extend into retirement.

Build a De-accumulation Product Menu

Think about the well-informed 58-year-old pre-retiree who believes that, at this age, a more conservative investment approach is the right way to go. Typically, that means transitioning out of equities—particularly given the market shocks of the past few years. But abandoning equities can severely limit potential returns, particularly in a low interest rate environment—and this savings plan needs to provide lifetime retirement income through the plan member’s 70s, 80s and, for an ever-increasing number, well into his or her 90s.

The challenge is that investment options designed for accumulators may not meet the needs of those looking to de-accumulate. By limiting the in-plan options available, sponsors may be limiting the potential of that individual’s savings to provide lifetime retirement income.

One approach is to expand the plan’s investment options—to carefully choose a de-accumulation menu the same way you would choose the accumulation menu. The financial services industry is addressing this significant trend through innovative product development. These new products are coming to market frequently and need to be evaluated, particularly in the context of changing demographics. Generally, there are three types of suitable de-accumulation products.

1| Annuities are the traditional de-accumulation vehicle. Structured as insurance contracts, annuities provide a steady stream of income for a guaranteed period of time in exchange for an upfront premium payment. Some may offer optional features, such as inflation protection, joint last-to-die coverage and survivor benefits. While annuities eliminate financial market risk, there is no potential for future growth because the monthly payment received is based, in part, on the prevailing interest rates at the time the annuity was purchased. Up until recently, annuity contracts were irrevocable and the individual would lose access to this capital, which, for some, was a drawback. But ongoing product innovation in this space may, however, change the annuity landscape and offer greater flexibility.

2| Guaranteed minimum withdrawal benefit products are insurance contracts that provide a guaranteed income for life. The capital used to buy the contract can be invested in a variety of investment options enabling potential growth and giving the purchaser ongoing access to the capital. The options and features may add complexity for plan members, and the cost of the guarantee can reduce investment performance.

3| Income-generating mutual funds provide ongoing access to capital and continued growth potential. There are many different investment options available. However, the investor remains exposed to financial market risk, and while the cash flow can be predictable, it is not guaranteed. When evaluating income funds, it’s important to recognize that not all income products are created equal, nor do they behave identically in various markets. Conventional solutions such as fixed income funds definitely have their place. However, those products that seek out alternate forms of income investments—such as dividend-paying equities, real estate investment trusts or infrastructure investments—can help ensure that your plan offers a diversified range of investment options that better respond to varying risk tolerance levels and investment time horizons as well as market conditions. Plan members should also be able to choose from a lineup of stand-alone income funds as well as managed portfolio solutions.

For most plan members, the ideal retirement income solution is a mix of the above and will also depend on members’ own individual needs and other potential income sources at retirement. By providing de-accumulation options, coupled with the appropriate advice and communication, plan sponsors can help their members focus on the investment outcomes they need to achieve beyond simply accumulating savings for some magical retirement date.

Access Post-retirement

Once plan sponsors have developed the de-accumulation menu for the transition period to retirement, the next step is deciding whether or not to give employees access to those same investments post-retirement. For many plans, members are required to change their investment options when they retire and leave their workplace plan. Somewhere implicit in that requirement to change options is a potentially dangerous signal to members that retirement day is the right day to change their investment mix—which may not necessarily be the case.

This raises the question, Should plan members be able to stay in the plan after retirement? It would certainly make life simpler for plan members and avoid sending the “it’s time to change” signals.

That’s the can side of the de-accumulation question. Sponsors can help plan members understand how to de-accumulate. They can offer some level of advice. They can provide income options—both pre- and post-retirement—that come with or without guarantees.

There are two well-argued sides to the de-accumulation dilemma. Those on the capital accumulation-only side say, “We provided the benefit. Plan members made their own decisions. We have no further obligation.” Those on the “We should do more” side argue that plan sponsors have a fiduciary duty to help plan members prepare for their future and, therefore, that DC plans need to specifically address income generation at retirement.

Is it better for plan members to be “nudged” or not? If plan sponsors don’t provide income options, have they negatively impacted the financial future of their plan members? And if they do expand their de-accumulation options, will they be on the hook if things don’t turn out as planned?

It’s safe to say that the vast majority of plan sponsors do not want to take on any further fiduciary responsibility. But in fulfilling the responsibility that’s already there, some say there is an obligation to work toward optimizing plan design to help plan members complete their retirement planning cycle.

Whatever plan sponsors decide to do individually as an organization is their own decision. Collectively, however, the DC industry is at an inflection point in terms of facilitating de-accumulation strategies as part of workplace plans.

Lori Landry is chief marketing officer and the head of institutional business with Sun Life Global Investments. lori.landry@sunlife.com

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