When employers help employees increase their retirement income, everyone benefits. Older workers can retire when they want to — with a more secure future — and employers have greater flexibility in managing their workforces.
One of the most important steps US employers can take is to offer their employees retirement income generators, particularly systematic withdrawals, immediate annuities, and hybrid products. Because these methods take advantage of institutional rather than retail pricing, they may be able to increase workers’ retirement income anywhere from 5% to more than 20%.
They also help employees guard against the pitfalls of having to figure out on their own how best to generate a lifetime retirement income. Most 401(k) and other defined contribution (DC) retirement programs pay out a lump sum at retirement and leave it up to employees to chart their own paths. Many employees withdraw amounts that are too high and exhaust their savings prematurely, whereas others worry about that possibility and withdraw too little — unnecessarily cutting back on their standard of living.
One way employers can help is by making systematic withdrawals work better for employees. With this approach, employees keep their savings invested in the employer’s DC program and set up an installment payment plan to provide retirement income.
By offering employees investment funds through institutional pricing, employers can help the withdrawals last longer and provide substantially more income. This will help employees avoid the risk that the set payments will not last long enough, which can occur if employees live considerably longer than they expected or the employer’s program experiences poor investment returns.
The advantage of institutional pricing was dramatically demonstrated in a recent analysis by the Stanford Center on Longevity and the Society of Actuaries. The analysis, “The Next Evolution in Defined Contribution Retirement Plan Design,” compared the impact of institutional and retail pricing on two applications of systematic withdrawals.
In the first, the withdrawal was fixed at retirement and was increased for inflation each year. The amount was paid until the employee died or the savings were exhausted, whichever came first. The analysis assumed that institutionally priced funds were charged annual management fees of 0.5% (50 bps) per year, whereas retail funds were charged 1.5% (150 bps) per year. The researchers projected that the money in savings would last two to three years longer with institutional pricing compared with retail pricing.
In the second application studied, the withdrawal amount was a constant percentage of the remaining assets at the beginning of each year. The analysis found that after 10 years, the income amount would be 10% higher with institutional pricing — and 21% higher after 20 years.
These annuities guarantee that retirement income is paid, no matter how long the employee lives or what happens in the capital markets. Payments are typically a fixed-dollar amount, although it is possible to buy annuities that increase at a fixed rate or for inflation.
Employers can help in two ways. The first is to offer an annuity bidding service, which searches reputable insurance companies to find the most competitive purchase rate at the time of retirement. According to the Stanford Center on Longevity/Society of Actuaries analysis, competitive bidding has the potential to increase retirement income by 10% to 20%. In addition, when employees are able to buy annuities at institutional rather than retail prices, it can reduce transaction fees by 4% to 9%, according to the analysis.
This approach combines the advantages of systematic withdrawals with those of annuities. Employees enjoy a higher retirement income if investments perform well, and that income is protected if returns are unfavorable.
With this type of hybrid product, known as the Guaranteed Minimum Withdrawal Benefit (GMWB), employees can access funds during retirement, and any unused funds at death are available for a legacy.
In addition to maintenance fees, insurance companiescharge annual fees for the added protection.
The Stanford Center on Longevity/Society of Actuaries analysis found significant differences between institutional and retail GMWB pricing. Annual management and insurance fees can be as much as 200 bps lower with the institutional pricing, the analysis found. With those lower fees, retirement income would be 12.5% higher initially, 16% higher after 10 years, and 19% higher after 20 years, according to the analysis. When the retail product is used, the amount of savings is reduced six years earlier, although income does continue, thanks to the insurance guarantee.
In addition to institutional pricing, employers can help increase their employees’ retirement income in other ways. Employers have the resources to fully analyze and perform due diligence on the various products — a task that is beyond the ability of most employees. And employer-sponsored programs help prevent the loss of savings due to fraud or mistakes.
When employers step in with retirement incomegenerating options, they help give workers the confidence of knowing they can retire when they are ready. As a result, employee engagement increases, and employers can better manage the workforce — two benefits that can provide a competitive advantage.
Learn more about how Mercer can help organizations create retirement-ready workforces.
|Fergal McGuinness (Zurich)
Global DC Leader
+41 44 200 4528
|Amy Reynolds (Richmond, VA)
+1 804 344 2639
|Arthur Noonan (Pittsburgh)
Senior Partner, Retirement
+1 412 355 8836