Your employer can boost your retirement income
Here's some good news for employees who have a retirement savings plan at work. Retirement plan sponsors can boost participants' retirement incomes 5 percent to 20 percent by offering a formal program of retirement income in their 401(k) plans, according to a recent paper by the Institutional Retirement Income Council (IRIC), a nonprofit think tank (Full disclosure: I'm the author of the paper.)
Currently, most 401(k) and defined-contribution retirement plans pay workers a lump sum at retirement. Workers must then figure how to turn their savings into a reliable paycheck that lasts the rest of their lives.
The IRIC paper proposes a better way: Plan sponsors can use their bargaining power, scale, ability to standardize and distribution efficiency to improve participants' financial security by offering a limited selection of retirement income generators (RIGs) that take advantage of institutional, rather than retail, pricing.
The IRIC paper looked at three ways of generating retirement income from savings: systematic withdrawals, immediate annuities and guaranteed lifetime withdrawal benefits. In each case, institutional pricing offers the potential to significantly increase retirement income.
Systematic withdrawals
With this RIG, you invest your savings and adopt a formal method for withdrawing a regular paycheck. While you can choose from a number of systematic withdrawal methods, the IRIC paper looked at two possible applications. The study assumed investment charges of 0.5 percent (50 basis points) for institutional pricing and 1.5 percent (150 basis points) for retail pricing.
The first income-generating method is a strict application of the 4 percent rule. With this method, your annual paycheck would be equal to 4 percent of your account balance at retirement, and you increase your withdrawal each year for inflation. You continue this strategy until you die or run out of money. The IRIC paper estimates that you would run out of money two to three years sooner with retail pricing compared to institutional pricing.
The second method is to calculate your annual retirement paycheck as 4 percent of the assets you have remaining at the beginning of each year. With this method, institutional pricing has the potential to increase retirement income by 10 percent after 10 years of retirement and by 21 percent after 20 years.
Note that the real comparison here is low-cost vs. high-cost mutual funds. Savvy investors can find mutual funds on their own with charges of 0.5 percent or lower. Plan sponsors can help by doing the shopping for their participants and offering low-cost funds in their 401(k) plan.
Immediate annuities
The second RIG the IRIC paper examined was immediate annuities. That's when you give your savings to an insurance company, and it promises to deliver a monthly paycheck for the rest of your life, no matter how long you live. The IRIC paper examined annuity bidding services that can be offered in retirement plans, where the service bids your savings to a handful of preselected insurance companies and selects the best rate of income at retirement. Such competitive bidding has the potential to increase retirement incomes by 10 percent to 20 percent, and reduced transaction charges have the potential to increase incomes by 4 percent to 8 percent.
Once again, savvy investors can use these services on their own, but plan sponsors can help by offering them in their plans.
Guaranteed lifetime withdrawal benefits (GLWB)
GLWBs are hybrid insurance contracts that combine the features of systematic withdrawals with the lifetime guarantees of annuities. With GLWBs, your retirement income has the potential to increase if investment returns are favorable. If returns are unfavorable, your retirement income is guaranteed not to drop. Participants can access funds throughout retirement, and any unused funds upon the participant's death are available for a legacy. These features usually aren't available with the immediate annuities described above. GLWBs typically assess an annual insurance fee in addition to investment management fees.
Institutionally priced GLWBs offer at least two advantages over retail GLWBs:
- The annual insurance and investment management fees can be as much as 2 percent lower (200 basis points) with institutional GLWB contracts compared to retail products.
- The initial income amount can be as much as 12 1/2 percent higher for institutional contracts compared to retail GLWB products.
The IRIC report projects this gap in GLWB income will widen to 16 percent after 10 years and to 19 percent after 20 years, due to the lower fees for both insurance charges and investment management expenses.
In this case, it's difficult for individual investors to find GLWB products on their own with institutional pricing, unlike the first two RIGs described above.
The bottom line is that costs matter with any type of RIG, whether you prefer an insurance or investing solution, or some combination of the two. Ask your employer to help by offering institutionally priced investments in your 401(k) plan. If enough employees create a demand, employers often respond.
