Retirement Annuity Accounts

A defined contribution benefit plan option to help stabilize retirement and reduce risk

Retirement Annuity Accounts

Posted by Michael Niciforo and Gursh Jhuty on April 07, 2016.

Will I be able to retire? is a question many employees are asking. More than 85 percent of Americans believe the nation is facing a retirement crisis1 and 72 percent of surveyed employers feel only some employees will be ready for retirement.2 Part of the issue is that many employers who previously sponsored defined benefit (DB) plans (such as pensions) have shifted to defined contribution (DC) plans (such as 401(k)s), putting employees in charge of managing and bearing the risks of investing for their retirement. A new plan design option, Retirement Annuity Accounts (RAAs), helps bridge the gap between traditional DB and DC plans, providing defined benefit features without the investment risk and compliance requirements of a defined benefit plan.

A solution to help manage risk
As a response to market conditions, many employers have shifted to DC arrangements to reduce risk and liability on the books. While many Baby Boomers have a DB plan with life annuity options, the upcoming retirees are likely to either not have a DB plan or their DB plan was frozen years ago. In 1998, 60 percent of Fortune 500 companies offered a defined benefit plan to new hires; by the end of 2013, that number had decreased to 24 percent.3

The markets have been very volatile in the past decade, and employees are starting to realize their current DC retirement savings are not sufficient. Also, as account balances have grown larger, small market downturns cause thousands of dollar of loss in account value, and the responsibility of managing one’s own retirement has become burdensome on individuals.
Now, through employer-sponsored 401(k) plans and other DC arrangements, employees are forced to take responsibility for their own retirement investments, including taking on greater risks they are not well-equipped for.

A Retirement Annuity Account is a financial product that would help employers and employees manage retirement risk while providing participants a stream of future lifetime payments. RAAs relieve both employers and employees of the burden and risk of investment management by leveraging the expertise of the insurance industry and other annuity providers. Insurers already manage risk for property, health, disability, and death for employees and the general population and are well-suited to take on this role.

A complement to current retirement plans
It is very difficult for financial markets to perform well enough for an investments-only retirement income plan (like a 401(k)) to provide guaranteed stable income streams. This desired stability can be created by including an RAA as part of an integrated plan that includes an employer’s current retirement plan.

How it works—an example
Each year, an employer would provide a pre-tax contribution in a DC plan (such as an existing 401(k) plan) on behalf of the employee. The contributions would accumulate until age 454 in a stable value-type investment, an indexed fund, or a life cycle fund. Starting at age 45, 1/20th of the balance would go to an annuity provider, where it is then converted into a monthly annuity payable at age 65. The following year 1/19th of the balance would be converted. This would continue until the entire balance has been converted. The annual employer contributions made after age 45 would be directly converted into an annuity.

This tiered approach provides younger participants with some growth opportunities in earlier years and still provides a long enough horizon where their balances are converted into annuities. It also reduces the interest rate risk, as annuities would be bought over a 20-year period.

The amount of the annuity purchased is based on market interest rates set by the insurance company on a daily, weekly, or monthly basis. These annuities will be tracked by the annuity provider and investment management companies on the employee’s behalf, as with any other retirement plan benefit. Each year starting at age 45, the annuity purchased with the portion of the balance and new contribution will vary based on interest rates, market conditions, and the participant’s age. The annuity amount will grow each year by the current annuity purchased for the employee. The employer may change annuity providers periodically as they do with any retirement plan provider, but is likely to stick with one insurance company if the pricing and services provided are satisfactory.

From the employee perspective…
Annuities are payable at the normal retirement date and priced based on market interest rates, mortality, and the participant’s age. Employees would maintain relationships with annuity providers in a similar manner as they currently do with retirement providers, including being able to track their balances over time.

In terms of account administration, employees under 45 would have their assets in an account that could be rolled over if they change employers. Upon termination from their current employer, participants may be able to withdraw from the portion of their balance that has not been converted into an annuity at any time similar to any other DC plan. The amount that has been converted into an annuity may be withdrawn for limited reasons, and for pricing purposes this amount would be limited to the initial principal used to purchase the annuity. At the time of retirement, employees could also choose to take their annuity in various options depending on their marital status (e.g., over their lifetime or over the combined lifetime of employee and spouse).

A DB-type benefit for DC-level risk
For effective retirement planning and retirement income, we must step away from the notion that either investments or lifetime income options alone will best serve retirees. More emphasis is needed on the basic forms of lifetime income products, and how they may behave as part of an integrated retirement income plan. It is more difficult than typically realized for the upside growth potential of DC investments alone to beat the risk-pooling features of insurance and income annuities. Retirement Annuity Accounts, combined with DC savings and Social Security benefits, can provide employees more stable and comprehensive retirement income.

Moreover, RAAs can support employers’ efforts to differentiate themselves and be seen as an employer of choice. Employers can better assure employees have a sufficient source of secure and predictable income at retirement, while reducing the burden on employees for managing risk. At the same time, employers can better manage administrative, compliance, and investment risk burden and cost volatility for a more portable workforce.

Michael Niciforo is a principal in the Actuarial, Rewards and Analytics practice of Deloitte Consulting LLP.
Gursh Jhuty is a senior manager in the Actuarial, Rewards and Analytics practice of Deloitte Consulting LLP.

1 National Institute on Retirement Security, “New report finds 86 percent of Americans believe nation faces retirement crisis,” Business Wire, March 5, 2015.
2 2014 US Annual Defined Contribution Benchmarking Survey, Deloitte.
3 TW analysis of 2013 Fortune 500.
4 This is an optimal age for annuity pricing and managing interest rate risk, however the age can be different depending on price points and assumed retirement age.

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