Helping Plan Participants Help Themselves: Withdrawal Strategies in a Self-Serve World

Transcription

1 Helping Plan Participants Help Themselves: Withdrawal Strategies in a Self-Serve World PSCA Annual Conference May 1-3, 2018 Contributors from the PSCA Investment Committee: Philip Murphy, CFA, S&P Dow Jones Indices Steve Vernon, FSA, Stanford Center on Longevity Kevin T. Hanney, CFA, United Technologies Corporation Kenneth Levine, FSA, United Technologies Corporation Editor: Jody Strakosch, Strakosch Retirement Strategies, LLC Withdrawal Strategies in a Self-Serve World Page 1

2 Table of Contents Executive Summary 3 Solving the Right Problem 4 From Theory to Practice: A Portfolio Approach to Retirement Income Security 4 A Framework for Comparing Withdrawal Strategies 7 The Spend Safely in Retirement Strategy 10 Innovative Withdrawal Solutions: Two Case Studies 12 Page Prudent Investor Advisors 12 United Technologies Corporation 14 Conclusion 21 Appendix 23 References 24 A Policy Proposal 25 Withdrawal Strategies in a Self-Serve World Page 2

3 Executive Summary The PSCA investment committee suggested that a small group write a paper for the May 2018 Annual Conference that would discuss different strategies to create retirement income streams for plan participants. Importantly, the paper would also offer suggestions for elements of a due diligence process designed to meet fiduciary requirements for the selection and monitoring of products and service providers involved in the management and delivery of such options. We offer this field manual as a practical guide for those sponsors and their advisors who are seeking a framework for assessing retirement income solutions. We share the view of other PSCA investment committee members that retirement income is a critical topic for regulators, plan sponsors, and ultimately plan participants. Innovation and thought leadership in the field has evolved to the point where concepts more closely associated with prudent asset management, such as diversification, can now be applied to crafting retirement income solutions. Therefore, we would encourage plan sponsors to actively consider providing appropriately tailored retirement income-oriented solutions. Implementation at the plan level can be tailored to reflect a balance of characteristics that is consistent with sponsors policies and perspectives. For many participants, a prudent withdrawal strategy will need to be an integral component of their overall retirement income strategy in order to balance competing desires for stable income, access to savings, and growth potential. With the seismic shift in sources of retirement income, from that of employer defined benefit plans to individual defined contribution accounts, many Americans are woefully unprepared in their retirement readiness. Many Americans now need not only to provide funding for their own retirement, but also to design and build a sustainable strategy to support their spending in retirement. The passage of the Pension Protection Act of 2006 (PPA) went a long way in providing a regulatory framework for plan sponsors to help with accumulating retirement assets for plan participants. However, it did not go far enough to help participants with solving their needs for lifetime income strategies. Plan sponsors may want to consider evaluating their plan withdrawal strategies in the context of reviewing how income streams may be structured. Withdrawal strategies could include systematic withdrawal plans, partial or ad-hoc withdrawals, income annuities as a plan distribution feature or as a roll out into Individual Retirement Annuity, as well as variety of other draw down strategies. In this paper, we provide three innovative approaches of retirement income strategies, one from an individual perspective and two from an employer-sponsored or institutional perspective. No single retirement income or withdrawal strategy approach can be optimal for all participants. But there are a growing number of solutions that can meet the needs of many participants. We believe plan sponsors can play a pivotal role in making these strategies available to their participants. We must continue to push for a new regulatory framework to help plan sponsors in resolving concerns about their fiduciary roles, similar to that provided by the automatic enrollment rules that came out of the PPA and fostered the safe harbor that defined the Qualified Default Investment Alternative (QDIA) that is now ubiquitous across employer-sponsored retirement plans today. Withdrawal Strategies in a Self-Serve World Page 3

4 We find that sustainable retirement income strategies are critical to achieving dignified retirement outcomes. Innovation has taken hold in the retirement income space, and plans should seek to offer solutions that reflect withdrawal policies with the potential to benefit the majority of their participants. Importantly, there is enough choice in the marketplace that plan sponsors should make a conscious choice about the withdrawal policy they wish to adopt and then fulfill that objective by implementing a solution designed to deliver on that goal, rather than letting product mix dictate withdrawal policy. Solving the Right Problem A significant shift is taking place in how we collectively understand the mission of defined contribution (DC) retirement plans. Until now, the primary focus of DC plans has been helping participants to accumulate assets for retirement. DC plans have not necessarily focused on outcomes, and many have avoided offering anything resembling a commitment to provide any form of income certainty in retirement. Yet, as the primary retirement plans for a growing number of workers, there is increasing acknowledgement that if these plans are not going to provide guarantees, then they ought to at least provide reasonable opportunities for retirement success. A critical component of retirement success for many people is structuring withdrawal strategies that facilitate regular paychecks. Creating a paycheck encourages a budgeting discipline to meet both core and discretionary spending. We encourage DC plan sponsors to assess, or re-assess, the design goals of their plans. Wealth accumulation is a necessary element on the path to retirement success but, by itself, is insufficient. Plan participants also need tools to transition from growing wealth to generating income. For many, the most reliable and cost-effective method of successfully negotiating that transition could be through a mechanism within their employer-sponsored retirement plan. From Theory to Practice: A Portfolio Approach to Retirement Income Security With the decline of traditional pensions, many older workers and retirees face a "do it yourself" retirement: They're on their own to figure out how to make their retirement savings last for the rest of their lives. With retirements that can extend 20 to 30 years or more, this is indeed a daunting challenge for those who are fortunate enough to accumulate significant savings by the time they retire. New thinking is needed To address this challenge, different thinking and new language is needed, to transition from a mindset concerned with accumulating assets for retirement, to a mindset concerned with generating income in retirement. To help with this mindset transition, plan sponsors and their participants can apply portfolio concepts that the DC industry has successfully used to accumulate assets. When workers are saving for retirement, classic investment portfolio theory advocates that they diversify their savings among different types of asset classes, each having distinct characteristics and each expected to perform differently in up versus down markets. This is called the "asset allocation decision." Applying this theory to asset accumulation Withdrawal Strategies in a Self-Serve World Page 4

5 means many retirement savings portfolios have a mix of stocks, bonds and cash investments. This is the common definition of "portfolio diversification." When workers are accumulating assets, investment risk is expressed as the possibility that their portfolio might lose money or not keep up with inflation. The goal of asset allocation is to minimize the odds of these undesirable outcomes over the time horizon that applies to workers (typically until the age they expect to retire). But things get more complicated when older workers retire and use their savings to generate income for the rest of their lives. To help meet these new goals, they can apply portfolio thinking by diversifying their savings among different types of retirement income generators (RIGs) to build a retirement income portfolio. They can allocate their retirement savings to RIGs that not only perform differently in up versus down markets but also have different characteristics regarding these goals: how much income they can expect, how long the income might last, whether their income can be expected to keep up with inflation, and how much accessible wealth (liquidity) they might have at any time. Individuals and their families may also desire other features to meet different life circumstances, such as bequest motives. How they allocate their savings to various RIGs is called the "retirement income allocation decision." Retirement income risk may then be expressed as the possibility that the total amount of retirement income may decrease by an undesirable amount or not keep up with inflation, or that retirees might have insufficient liquid assets at any point. The goal of retirement income allocation is to minimize the odds of these undesirable outcomes for the rest of their lives. The uncertainty about how long retirees might live is one of the key challenges of retirement income planning. Common retirement income goals Here are common goals that retirees might have for constructing their retirement income portfolio: Generate a lifetime retirement income that cannot be outlived Maximize the amount of retirement income expected to be paid over one s lifetime Minimize the odds that the total retirement income will fall below an undesirable level, usually due to stock market volatility Provide the potential for growth in income to keep up with inflation Maintain access to savings in case of unforeseen expenses, such as medical or long-term care. Preserve the ability to leave behind unused funds as a legacy Protect against common risks: o longevity o inflation o investment o death of a spouse Withdrawal Strategies in a Self-Serve World Page 5

6 o o o cognitive decline and mistakes fraud political/regulatory issues (changes in laws or regulations on retirement plans or Social Security, or the taxation of these benefits) Select investments that are easy to use and don't need continual monitoring and adjustment, or that protect retirees against fraud and mistakes (they'll appreciate this goal when they reach their 80s and beyond) Unfortunately, no single RIG delivers on all these goals, so retirees will need to prioritize and make tradeoffs among them. For each retiree, some goals may be more important than others. This is a valid argument for diversifying retirement income sources, so the entire retirement income portfolio might address all the goals that are important to a specific retiree. Building retirement income portfolios Here are common retirement income generators (RIGs) that have distinct characteristics regarding the above goals, each with different advantages and disadvantages: Drawing from Social Security Investing savings and using a systematic withdrawal plan (SWP) to generate a retirement paycheck Investing savings and living off the interest and dividend income Buying a guaranteed lifetime annuity from an insurance company (think of it as a personal pension) Working or self-employment income Generating money from real estate rental income or a business Obtaining a reverse mortgage Plan sponsors can play a role by offering tools or services that may help participants with the first five RIGs. These strategies, used in combination or individually, depending on one s total financial picture, may help meet retirement goals: Cover most or all of basic, necessary living expenses with guaranteed sources of lifetime retirement income that are protected against loss of principal. Such sources include Social Security, annuities, SWPs with conservative drawdown and investment features (e.g., stable value funds within employer-sponsored plans), and tenure payments from reverse mortgages. In essence, this is the bond part of a retirement income portfolio. Pay for discretionary living expenses with invested savings, possibly with a significant investment in equities. This is the growth portion of a retirement income portfolio. Recent research by the Stanford Center on Longevity (SCL), in collaboration with the Society of Actuaries (SOA), shows how retirees can assemble a portfolio of retirement income from the various sources described above. 1,2 This research demonstrates that Social Security meets more retirement planning goals than any other RIG, as follows: Withdrawal Strategies in a Self-Serve World Page 6

7 It helps maximize the amount of expected retirement income through a thoughtful optimization strategy It helps minimize taxes by excluding part or all of income from taxation It protects against most common retirement income risks: o Longevity o Inflation o Investment o death of a spouse through the survivor s benefit o cognitive decline, mistakes, or fraud that could result in the loss of savings It is simple to implement and has no transaction costs As a first step in building a retirement income portfolio, it makes sense for workers to maximize the value of this important benefit, usually by delaying the start of benefits for the primary wage-earner. The optimal strategy for a married couple often depends on their specific circumstances, and it may be desirable to use commonly available software or consult a financial adviser who specializes in Social Security optimization. The SCL/SOA research also demonstrates that for many middle-income retirees, Social Security income might represent two-thirds or more of the total retirement income portfolio. In this case, Social Security may be the only annuity income that a middle-income retiree requires. A Framework for Comparing Withdrawal Strategies An important concern for plan sponsors is their exposure to fiduciary liability when selecting and communicating retirement income solutions to offer plan participants. ERISA requires plan sponsors to act in the best interests of plan participants, which the courts have characterized as requiring fiduciaries to engage in a prudent decision-making process. Plan sponsors and their advisers can use rigorous, documented analyses as part of the prudent decision-making process when designing payout options. The SCL/SOA research mentioned previously provides one example of such analyses that used stochastic forecasts and efficient frontiers. These are analytical techniques used by large plan sponsors and their consultants to devise funding and investment strategies for defined benefit plans or the investment menu for defined contribution plans. Other analyses can be used as part of a prudent decision-making process. The SCL/SOA project systematically compared 292 different retirement income solutions, using stochastic forecasts and efficient frontiers. The efficient frontier demonstrated the tradeoff between the amount of income expected over the retirement period to the amount of accessible wealth expected over the period, for various hypothetical retirees. Figure 1 shows one such analysis; in this graph, each symbol (dot, cross, etc.) represents a specific retirement income solution (including Social Security benefits). The most favorable place for a given solution to be in this graph is the upper right-hand corner, maximizing both the amount of income and accessible wealth. Figure 1 shows there s a quantifiable tradeoff between those two goals. Withdrawal Strategies in a Self-Serve World Page 7

8 Figure 1: Example of efficient frontier using stochastic forecasts, for a single female age 65 with 250,000 in retirement savings The SCL/SOA project then selected retirement income solutions that were on or close to the efficient frontier for further analysis, using the following eight retirement income metrics: 1. Average annual real retirement income from the specific solution expected throughout retirement, including Social Security. 2. Expected direction of retirement income: Is income expected to keep pace with inflation or fall behind? 3. Average real accessible wealth expected throughout retirement, weighted by the probability of surviving to each future age. 4. Expected direction of accessible wealth: Is accessible wealth expected to decrease or grow throughout retirement? 5. Average real bequest at death. This is the average amount of real remaining savings projected at each age throughout retirement, weighted by the probability of dying at each future age. 6. Undesirable volatility. This measures the average annual decrease in total retirement income when such a decrease occurs, due to poor investment performance or excess inflation. As such, this measures the potential need to reduce spending in a future year. This helps retirees Withdrawal Strategies in a Self-Serve World Page 8

9 understand the comfort margin they might have with their budget for living expenses. Note that such decreases can be offset by past or future increases in income. 7. Probability of plan failure: What are the chances that total retirement income will fall below a specified minimum threshold? 8. Magnitude of plan failure: What are the projected magnitudes of failure? These metrics help analyze how well each solution meets various retirement income goals. This analysis enables plan sponsors, retirees, and their advisers to decide on retirement income solutions that provide an appropriate tradeoff between different retirement goals. The SCL/SOA report prepared dashboards that graphically display the results of these metrics. Figure 2 shows an example of one dashboard. These analyses provide just one example of a documented process that a plan sponsor can use to design and implement a program of retirement income. Other analyses can also demonstrate that plan sponsors and their advisers are conducting a prudent decisionmaking process. Figure 2. Sample dashboard comparing six different retirement income solutions for a 65 year-old female retiree with $250,000 in retirement savings. Source: Stanford Center on Longevity. Withdrawal Strategies in a Self-Serve World Page 9

10 The next section of this paper looks at one specific retirement income strategy that the SCL/SOA project identified using these analytical techniques. This strategy meets a number of retirement planning goals that older workers and retirees may have. The Spend Safely in Retirement Strategy The SCL/SOA research identified a straightforward retirement income strategy that produces a reasonable tradeoff among the various retirement planning goals for middle-income retirees. 3 It can be readily implemented from virtually any IRA or 401(k) plan without purchasing an annuity. As such, it can serve as a baseline retirement income strategy that plan sponsors can readily implement, perhaps as their initial effort to help plan participants generate income in retirement. The Spend Safely in Retirement Strategy delays Social Security income as long as possible, but no later than age 70 for the primary wage-earner. If the worker retires before starting Social Security benefits, the worker would use a portion of savings for a retirement transition bucket that would replace the Social Security income while it s being delayed. The retiree would use the IRS required minimum distribution (RMD) to calculate income from remaining savings, with assets invested in a low-cost target date, balanced, or stock index fund. The RMD is required at age 70-1/2; using the IRS tables that specify life expectancy, one can determine the appropriate withdrawal percentage, in this case 3.65%. Before that age, the worker would use similar methods to calculate the annual withdrawal or use a simple withdrawal percentage such as 3.5%. 4 The SCL/SOA research shows that the Spend Safely in Retirement Strategy has many key advantages when compared to 292 different retirement income strategies. For example, it: balances many of the goals and tradeoffs described previously, produces more average total retirement income expected throughout retirement compared to many strategies, and provides equal or better protection against the common retirement risks described previously, such as longevity, inflation, investment, and cognitive risks. In addition, plan sponsors/plan administrators can use this strategy to prepare retirement income statements, by showing estimated Social Security benefits starting at various ages as well as estimating RMD payout amounts. The Spend Safely in Retirement Strategy emphasizes that it s smart for retirees to: Delay drawing down Social Security and retirement savings. For workers with modest retirement savings, it s essential to squeeze every dollar out of available retirement resources. For example, in one study, delaying retirement by one year boosted projected retirement income more than saving an extra 1% of pay for 30 years. 5 Automate the payment of retirement income, which will be very helpful for older retirees when they reach their 80s and 90s and are less interested in managing their finances. Use low-cost index funds for invested savings. Withdrawal Strategies in a Self-Serve World Page 10

11 Gradually shift from full-time employment to part-time and eventually to full retirement. The right transition will be unique to each retiree s circumstances and goals. Adjust withdrawals from retirement savings for investment gains and losses throughout retirement. Maintain some accessible savings to respond to changes in circumstances throughout retirement. As such, this strategy can be characterized as a navigational guide to help older workers decide when to retire and how to deploy their retirement savings. For details on the Spend Safely in Retirement Strategy, including the advantages and disadvantages, investment and communications considerations, and refinements to the strategy, see the paper titled How to Pensionize Any IRA or 401(k) Plan. How plan sponsors can help Plan sponsors can help their older workers and retirees build a retirement income portfolio through a basic program of distribution options in their DC plans. Such a basic program would offer at least three payout options with the following features: To help implement a systematic withdrawal plan (SWP), a plan sponsor can offer an installment payment feature that pays specified amounts in the frequency elected by the retiree (monthly, quarterly, or annually). The retiree could specify a percentage that s applied to the remaining account balance at any time, such as 3%, 4%, 5%, or 6%. The SWP would be coupled with low-cost target date, balanced, or stock index funds. A plan could adopt the RMD as an explicit default retirement income strategy and communicate its features to participants. When coupled with the plan s QDIA for retirees, this strategy might offer fiduciary protection to the plan sponsor, since the plan sponsor is complying with IRS regulations, and significant penalties could result from noncompliance. Participants could then make a positive election for any other retirement income option offered under the plan. To help optimize Social Security benefits, a plan could offer a period certain payout for workers who retire before age 70, the optimum age for starting Social Security benefits. The period certain payout would replace the Social Security benefits the retiree is delaying. The period certain payout could use the plan s stable value, money market, or short-term bond fund as the underlying investment fund(s). For workers who desire more guaranteed income than Social Security, the plan sponsor could offer an in-service withdrawal feature at age 59-1/2, so that older workers and retirees could roll accounts out to an annuity bidding service to purchase deferred or immediate income annuities. In effect, the above basic structure uses guidance under ERISA Section 404(c) on the investment menu as a template for structuring a program of retirement income. 6 This structure offers three distinct retirement income options systematic withdrawals using invested assets, a period certain payout to help optimize Social Security, and the ability to purchase a guaranteed life annuity. Retirees have the ability to allocate savings freely among the various retirement income options at the time of retirement. This structure mimics the basic requirements of an investment menu under ERISA Section 404(c). Withdrawal Strategies in a Self-Serve World Page 11

12 Plan sponsors that want to offer more robust retirement income programs could offer alternatives such as immediate income annuities, guaranteed lifetime withdrawal benefits (GLWBs), Qualifying Longevity Annuity Contracts (QLACs) and advisory services for invested assets. In summary, plan sponsors can help their older workers and retirees by: automating RMD as payment option in their plan, offering period certain payouts to enable Social Security delay, adopting the RMD + QDIA as the default payout option, offering low-cost index funds, providing education, tools, and retirement income statements, shopping for qualified, unbiased retirement planning assistance, and offering alternative career paths for older workers to help them transition into retirement, by optimizing their Social Security benefits and delaying withdrawing from their retirement savings. These steps will go a long way to helping older workers decide when to retire, whether they need to work part-time for a period of years, and how much they can spend in retirement. Innovative Withdrawal Solutions: Two Case Studies PSCA s investment committee thought it would be helpful to examine two institutional approaches to providing retirement income solutions to DC plan participants. The first case study is from the perspective of a financial advisor to employers for their plans and plan participants; the second case study is from a plan sponsor that has implemented a custom retirement income program. Target Date Fund Case Study: Prudent Investor Advisors and Dimensional Fund Advisor s Target Date Retirement Income Funds (An interview with Gary K. Allen, Principal, Prudent Investor Advisors) Prudent Investor Advisors (PIA) specializes in helping plan sponsors of 401(k) and other retirement plans with the selection, monitoring and replacement of plan investment options by serving as an ERISA section 3(38) and a 405(d)(1) independent fiduciary. In this role, PIA accepts the transfer of fiduciary responsibilities and liabilities from its plan sponsor clients. PIA was established in 2004 with three partners; they have over fifty years of experience in the retirement plan industry in aggregate. The firm is an SEC registered investment advisor. They operate on a fee only basis and do not accept compensation from third party plan vendors, thereby assuring complete independence. PIA believes it is important to establish and follow a prudent investment and management process that is legally sound, academically oriented and cost efficient. PIA evaluated the early target date funds and was concerned that they didn t answer the question of, What then? once the plan participant retired. They developed their own risk-based model with a glidepath overlay. Even with this structure, they were still concerned with the long-term liabilities that plan participants faced once they reached retirement. Withdrawal Strategies in a Self-Serve World Page 12

13 PIA spent a significant amount of time evaluating new fund structures in the marketplace and found that the Dimensional Fund Advisors (DFA) Target Date Retirement Income Funds responded to their concerns. These funds represent a new generation of target date funds that have a more complete risk management framework than traditional target funds. This risk management approach categorizes investments into assets for income growth (increasing the balance available to draw income from) and assets for income risk management. The target date funds gradually allocate to a strategy designed to manage the uncertainty around future interest rates and inflation and the impact those two factors have on inretirement consumption. The funds use a TIPS strategy that seeks to match the expected cost of inretirement consumption through duration matching. This investment approach resonated with PIA because they know that plan participants want to continue to receive a paycheck once they retire. PIA also liked the liquidity aspect of these funds; both for the sponsor and the plan participant. Some other retirement options may not be portable or may not retain full liquidity. As Gary Allen described it, These funds allow employees to get 80-90% of what an annuity provides, without the guarantee, and with the advantage of complete liquidity, this is a good combination for most people. It offers most of what plan participants are looking for and provides both the freedom and flexibility to manage inretirement consumption. When Gary is working with his plan sponsor clients, he realigns the conversation to focus on the question of why are we saving for retirement? Everything should be driven towards the outcome of income. In other words, what is the future liability for the participants? PIA reviews the demographics of the plan and helps sponsors identify those segments of the population who will be retiring soon and looks at their needs in retirement. It is important that the sponsor agrees that educating participants to understand if they can sustain their level of lifestyle in retirement and about the choices they can make (Can you afford to save more today? Do you want to work longer? Should you delay taking Social Security?) is a critical component of the service PIA provides. When it makes sense, Gary recommends that the plan sponsor use DFA s Target Date Retirement Income Funds as the QDIA for the participants. They review the plan documents and make any necessary changes to allow the sponsor to reenroll all participants into the new QDIA. PIA has found that negative election works very well and that these investment funds are generally appropriate for approximately 85-95% of the population. As Gary said, Good plan design is one of the keys to good outcomes. Another critical step to reaching a good outcome is to work with the plan participants so that they understand what their estimated retirement income will be. This is very easy to accomplish by using DFA s My Retirement Income Calculator. The calculator is designed to help give an investor a sense of how much potential income their total investments may provide in retirement. Generated from investment withdrawals, income estimates are based on several inputs that an investor provides, along with assumptions regarding a shifting asset allocation and expected returns on investments. The participant can adjust these inputs, including their monthly contributions, retirement age and expected Social Security benefit, to see how various retirement scenarios may affect estimate income. Withdrawal Strategies in a Self-Serve World Page 13

14 Gary believes that this interactive tool makes all the difference to the plan participant as it helps put them into the driver s seat. As he points out to his clients, participants who feel more financially secure are more productive at work. Using the Target Date Retirement Income Funds and the calculator tool is a really effective way to help participants become comfortable with the concept of retirement and managing their financial resources. PIA provides a range of communication tools to the participants, such as videos, to explain how to use the calculator. And, of course, estimated retirement income reports are also available. Implementing a QDIA, automatically enrolling participants in the plan and helping bring employees into the retirement conversation makes good business sense. This program also encourages participants to remain in the plan once they retire, which has several important benefits. One benefit is if assets remain in the plan, then everyone is likely to benefit from lower fees. And, for the participant, they are benefiting from the due diligence of both their plan sponsor and PIA. Furthermore, once in retirement the new retiree can customize their paycheck from the Target Date Retirement Income Funds. Gary and his PIA associates have introduced the Dimensional Target Date Retirement Income Funds to their clients over the past three years. Clients that have implemented this approach and are seeing the positive impacts of participants engaging with their retirement range from start up plans with a couple of employees to $300 million plans with 2,000+ participants. As Gary summarized, the two key elements of this program are 1) low-cost investment solutions that manage the right risks and balance the tradeoff between growth and risk management and 2) meaningful information to facilitate decision making. GLWB Case Study: United Technologies Corporation s Lifetime Income Strategy Background Effective January 1, 2010, United Technologies Corporation (UTC) closed its defined benefit plan for nonrepresented employees to new entrants. Knowing this meant that its future generations of employees would need to rely on the company s defined contribution plan as a primary source of retirement income, UTC was determined to enhance its plan design so that it would function as a pension for the 21 st Century. To do so, they needed to find an effective and affordable retirement income solution that paid particular attention to managing the longevity risk associated with generating retirement income from a DC plan. UTC s Lifetime Income Strategy was launched on June 1, 2012 as the plan s qualified default investment alternative. Getting to this design It is important to note that a partnership between UTC s Finance, Human Resources and Legal groups was critical to the successful design and implementation of the Lifetime Income Strategy. They shared a belief that retirement benefit plans are, at their core, tools that help manage UTC s most precious resource its people. UTC s pension investment staff worked very closely with employee benefits professionals and inhouse ERISA legal counsel throughout the development of their program and continually focused on some basic questions: Why are we offering a retirement plan in the first place? How can we design the plan to meet the needs of our employees? How can a properly designed retirement plan support the success of our business? Withdrawal Strategies in a Self-Serve World Page 14

15 These professionals ultimately agreed that launching the Lifetime Income Strategy was vital to elevating the company s defined contribution plan to function as the primary form of retirement benefits offered to UTC employees in the U.S. A critical step toward achieving a shared understanding occurred when UTC developed a set of plan design objectives similar to those included in the table below. UTC s service providers came to refer to this informally as a Retirement Policy Statement or RPS. The benefit of establishing a set of objectives and principles for plan design became clear almost immediately in that it focused the effort of a diverse group of stakeholders on common goals and supported the identification of a logical progression of steps toward achieving those goals. UTC s staff referred to the RPS frequently during the design and implementation of the Lifetime Income Strategy and often used the policies as decision support tools. UTC focused its efforts on designing a program that offered employees a simple and secure option for retirement planning, and provided an effective means of generating retirement income, while preserving liquidity and upside potential. To meet these objectives, the Lifetime Income Strategy needed to be flexible so that participants can take control of their own financial position and adapt when faced with unexpected circumstances in the future. UTC worked closely with experts in the area of lifetime income and identified several critical attributes of retirement income solutions that required careful consideration, such as: 1) longevity protection, 2) return of principal, 3) joint life and death benefits, 4) liquidity, 5) portability, 6) price certainty, 7) competitive cost, and 8) transparency. These features are all important. However, each feature is subject to a complex trade-off between cost and benefits and could not be viewed in isolation. It was essential from UTC s perspective to assess such trade-offs as a prudent fiduciary, taking account of the distinct circumstances of their workforce with an explicit understanding that participants in the UTC plan may each have unique individual needs and constraints. Here is an example of a chart that was helpful to UTC staff in comparing a range of retirement income alternatives across several key features. This is not meant to be prescriptive, but rather was based both on prevailing market conditions as well as the specific characteristics of UTC s U.S. employees and Withdrawal Strategies in a Self-Serve World Page 15

16 objectives of UTC s plan at the time of their analysis. It is possible that facts and circumstances could change and that it is possible they might reach different conclusions in the future. However, UTC s focus on design drove them to consider factors that they believe are important for anyone considering whether or not they might adopt a specific retirement income solution in relation to an employer-sponsored retirement plan. Understanding how a range of retirement income alternatives compare on these dimensions should be part of a prudent fiduciary s due diligence process. In general, retirement income features: a) may or may not last for a lifetime, b) may be acquired in exchange for explicit or embedded fees, c) might otherwise occur as the consequence of some conversion of qualified assets into one or more plan distributions, either in isolation or in combination with assets held outside of a qualified plan or other sources of income such as Social Security benefits or traditional pension benefits, and d) may accommodate opt-in and/or opt-out choice architecture. Withdrawal Strategies in a Self-Serve World Page 16

17 UTC s defined contribution plan offers a tiered investment option structure. The first tier, which functions as the plan default, can be thought of as their Let-A-Professional-Manage-It-For-You option, and is comprised of the Plan s lifecycle alternatives, including the Lifetime Income Strategy and a series of low-fee custom target date funds. Tier 2 follows a traditional Build-It-Yourself approach and consists of a lineup of core funds spanning a range of asset classes across the risk/return spectrum. Each core fund is named for the asset class in which it invests and is primarily passively invested with extremely low investment management fees. Tier 3, is designed for plan participants that want to maximize their choices and are comfortable doing their own due diligence as it is a virtually unlimited mutual fund window that can be thought of as Build-It-Yourself-with-More- Choices/Additional Fees. UTC s DC Plan Today As of the end of 2017, UTC s plan had over $22 billion in assets and 110,000 participants, more than half of which are former employees and their beneficiaries. At that time, the Lifetime Income Strategy was the fastest growing option in the plan and held over $1.1 billion of assets invested on behalf of nearly 31,000 participants. It is the default for new employees joining UTC s defined contribution plan. In order to understand how the Lifetime Income Strategy works, it s important to understand the foundation that it is built upon: New employees eligible for automatic enrollment in UTC s plan start saving today at a default rate of 6% of pay through pre-tax contributions that automatically escalate by 1% per year until they reach 10%. (Note: Employees have the option of setting higher automatic escalation limits up to plan maximums. Non-highly compensated employees may contribute up to 40% of pay, while highly compensated employees are limited to contributing 18% of pay to the plan.) UTC s plan accepts contributions from active employees on a pre-tax, traditional after-tax, and Roth basis, and permits age 50 and over catch-up contributions on both a pre-tax and Roth basis as well. Employee contributions automatically switch to traditional after-tax contributions when they reach annual pre-tax/roth contribution limits, ensuring that impacted employees not only continue to make their own contributions, but also continue to receive UTC s matching contributions. Most employees in the UTC plan receive matching contributions from the company that equate to 3.6% of pay and those employees who are not covered by the company s defined benefit plan automatically receive additional contributions from UTC that are independent of their own savings Withdrawal Strategies in a Self-Serve World Page 17

18 rate. These company automatic contributions vary by age, starting at 3% for those below age 30, and increase up to 5.5% for people age 50 and over. A participant s non-forfeitable ownership of UTC s employer contributions typically vests after two years of participation in the plan. These automatic default plan features mean that combined annual contributions for UTC s active employees will typically range from 16.6% to 19.1% of pay after four years of employment at UTC, even if they take no action at all and virtually all contributions go into the Lifetime Income Strategy by default. Furthermore, UTC s plan accepts eligible rollovers from all participants, including former employees, making it an effective medium for consolidating retirement savings within an exceptionally low-cost plan and preserving access to the Lifetime Income Strategy for those former employees who wish to augment their savings and the income benefits they acquired while working there. UTC s Lifetime Income Strategy provides a carefully constructed transition from wealth accumulation to income generation. When a participant is under age 48, the Lifetime Income Strategy is like a personalized target date fund built by an investment manager specifically for them. Starting at age 48, assets begin to shift into a component that provides several key features plan participants typically look for in a retirement income solution guaranteed cash flows, growth potential, flexibility, and access to savings. This part of the portfolio is called the Secure Income Sub-Fund. By age 60, the entire balance and all subsequent contributions to the Lifetime Income Strategy are allocated to the Secure Income Sub-Fund. Within the Secure Income Sub-Fund, an insured income base is established at inception and a guaranteed minimum income benefit is calculated. This income benefit increases whenever new money is added to the Secure Income Sub-Fund and when investment growth leads to new high market values, but it will not decline unless the participant takes an early or excess withdrawal, even if investment growth falls short of expectations. Participants in the Lifetime Income Strategy may activate and collect their income benefit any time after they reach age 60 and separate from service. The income benefit is adjusted if activation occurs at an age other than 65 or if the participant chooses a joint life option. Once activation occurs, the participant may withdraw as much or as little as he or she wishes from their Lifetime Income Strategy account balance. If the participant withdraws an amount equal to the income benefit, even if the full balance is exhausted, the income benefit amount will continue for life with payments continuing to the joint life if applicable. If a participant withdraws more than the amount of the income benefit, then the future income benefit will adjust downward. One of the most valuable features of the Lifetime Income Strategy is that it preserves the right to take out some or all of the remaining balance out of the account without any surrender charges. This allows the participant to fully customize the withdrawal pattern. If a participant has need to access the full remaining balance, that option is available. Also, unlike what would happen with a traditional annuity product, in the unfortunate circumstances of an early death of the participant and joint annuitant, the untapped balance is not lost. Withdrawal Strategies in a Self-Serve World Page 18

19 Another beneficial feature is that assets in the Lifetime Income Strategy remain invested in a diversified portfolio of stocks and bonds for life. This maintains a growth-oriented investment strategy with upside potential throughout retirement and supports a high likelihood that retirement income benefits will increase in the future due to investment performance. It s important to note that all retirement income alternatives involve tradeoffs, often between liquidity and income. More broadly this can be thought of as a balance between control and certainty as shown below. UTC considered this balance explicitly in its assessment of the range of retirement income generators available for use in the Lifetime Income Strategy. It compared and contrasted each alternative using a set of plan objectives and features that UTC deemed critical to the success of its plan participants and their ability to adapt and respond to the uncertainties that each one will invariably face in retirement. A participant who believes he needs a relatively high stream of income for a short period of time starting at retirement may wish to lock in on systematic withdrawals and leave it at that. Another participant who needs a steady stream of income and is sure she will outlive the mortality tables and all the actuaries who produced them, may take a distribution and buy a fixed annuity. UTC believes that most of its participants are unsure of their spending needs in retirement and thus need a product that offers the flexibility for either of these extreme scenarios or anything in between. Ultimately, UTC relied on tools and resources very similar to those described within this paper and determined that the Lifetime Income Strategy struck Withdrawal Strategies in a Self-Serve World Page 19

20 the right balance of control and certainty for its plan participants and hopes that other plan sponsors will do similar analysis to reach conclusions that are right from them and their participants. FAQ S Why did UTC make this in-plan income option available? UTC made this change because we believe retirement savings and income benefits are important to our employees. It s designed for employees who need an effective solution to help them navigate retirement, regardless of what life brings next. Younger employees aren t thinking about retirement, but we designed the Lifetime Income Strategy to account for that. Our solution focuses on achieving a degree of financial independence that is important to everyone. How does it work? In practice, the Lifetime Income Strategy actually works very much like a traditional pension; meaning that participants are enrolled when they are hired, their benefits grow over time and they activate payment of their income benefits at the point they wish to retire. Along the way, they can check the growth in their income benefits and account balances, run estimates of their projected retirement income and compare the results to their goals and objectives. However, unlike most traditional pensions, they have the freedom and flexibility to increase contributions or transfer and consolidate money from their other qualified retirement plans to build up even more value through the program if they are behind on their goals. Importantly, they always have the power move their money out of the Lifetime Income Strategy into other options in the UTC Savings Plan, even opt out entirely if their needs change. There are never any backend surrender charges. This is a sophisticated retirement income vehicle. Under the hood, it combines professional asset management, competitively bid income guarantees and an advanced operational platform, all delivered through a streamlined user interface and supported with simple, plain language printed and web-based communication materials. Savings rates are designed to be high. Automatic age-based company contributions ranging from 3.0%-5.5%, plus employee contributions are matched with up to another 3.6% for combined company contributions ranging from 6.6% up to 9.1%. Employee deferrals start at 6% through automatic enrollment and automatically escalate up to 10% by default, but can go even higher if people opt in. How has it been received by plan participants -- what's the take-up rate? What is the general tone around the water cooler? It s one of the fastest growing options in our defined contribution plan. In addition to it serving as our default for new hires, we ve seen thousands of our existing plan participants proactively transfer some or all of their account balances into the program. Employees who understand the goals and objectives of the option love it. Many are still learning about it and we ve recently rolled out a strong communications plan to reach them. Word-of-mouth among employees is a key driver as they explain the program, its benefits and recommend it to one another. Withdrawal Strategies in a Self-Serve World Page 20

21 Conclusion How well a society supports its members preparedness for life after full-time work is surely a measure of its value. America s leading institutions, several of whom we have highlighted in our case studies, recognize that helping individuals to help themselves in the pursuit of retirement security is a profound purpose benefiting all of society. With respect to the practical challenges of retirement security, it is important to remember that prudent retirement planning is more like a marathon than a sprint. Essential principles such as effective budgeting, diversification, and managing costs may not show dramatic results overnight, but pay off handsomely over the course of a lifetime. Crucially, effective retirement planning acknowledges that, while wealth accumulation is a necessary element on the path to retirement success, it is insufficient in isolation. Withdrawal strategies that facilitate regular paychecks are a critical component of retirement security. We encourage DC plan sponsors to assess, or re-assess, the design objectives of their plans. Individuals who are not participants in employer-sponsored retirement plans need to serve as their own guardians and advocates in the same manner that ERISA compels plan fiduciaries to act on behalf of plan participants and find high quality information to help them establish policies for transitioning from wealth accumulation to income generation. Establishing appropriate design goals are key steps for both plan sponsors and individuals. Both should strive to solve the right problem, which involves identifying fundamental tradeoffs such as striking a balance between income certainty and access to savings. Both should also strive to fulfill their design objectives with product solutions rather than letting product mix drive withdrawal policy they should make informed buy decisions rather than being sold on products. We encourage plan sponsors and individuals to proactively address the need for sustainable withdrawal strategies. For plan sponsors, an income focused regulatory safe harbor would accelerate adoption rates, but innovation and thought leadership has evolved to a stage where viable options for structuring withdrawal strategies are available today. Implementation at the plan level can be tailored to reflect a balance of characteristics that is consistent with sponsors policies and perspectives. No single retirement income or withdrawal strategy approach can be optimal for all individuals, but there is a growing array of solutions that can meet the needs of many. Withdrawal Strategies in a Self-Serve World Page 21