I am the fortunate father of three boys, ages 9, 7, and 5, and if I’ve learned one thing in my almost decade as a parent, it’s that each child is surprisingly different. Early on though, I naively expected that the parenting techniques I used with my firstborn would magically work with the others. Boy, was I wrong!
Eventually I realized, with help from my wife, that I need to apply a variety of tactics to meet their individual needs and demands. For example, my oldest son likes structure, but my middle son resists it. So to keep the middle son in line, we have to use a few more “carrots” and a lot more “sticks.”
Staying open to a variety of approaches is also important to a topic I study when I’m not at home: retirement income. As baby boomers retire en masse, our industry has shifted its focus from the challenge of helping workers accumulate assets to the challenge of turning those assets into a stream of lifetime income. Solving this puzzle is a complex undertaking because it must account for a wide range of individual circumstances and preferences.
Lifetime income in a QDIA?
One proposed solution is to add a lifetime income feature to qualified default investment alternatives (QDIAs). A lifetime income feature could exist in a variety of forms, including annuities, traditional investment portfolios with embedded payout features, and plan design options that provide for systematic withdrawals, among other variations.
The income feature I’m asked about most is the one involving annuities. Since target-date funds (TDFs) are the predominant QDIA today, this approach would essentially mean embedding annuities within TDFs. The thinking behind the idea goes something like this: TDFs have proven effective in helping investors save for retirement. Why not make a good thing even better by adding a guaranteed income feature to it?
On the surface, incorporating annuities into QDIAs seems reasonable. Annuities can be a great source of stable retirement income to cover basic living expenses and mitigate market and longevity risks. If a retiree’s basic living expenses aren’t covered by existing sources of guaranteed income, purchasing an annuity to make up the difference can make sense.
Vanguard has offered annuities for more than 20 years, and we understand the important role they can play in a comprehensive retirement plan. We’re also the industry’s largest provider of TDFs. After thoughtful consideration informed by our experience with both product types, we see several challenges associated with adding annuity features to QDIAs:
Lack of portability. Today’s workforce is increasingly mobile, and the typical worker will save across a number of employer plans and QDIAs. Adding annuities to QDIAs could limit the ability of participants with multiple plans to consolidate their assets. It could also limit plan sponsors’ ability to change plan design, service providers, and investment options.
Lack of demand. We’ve seen a limited appetite for annuity products from plan sponsors and investors. While this lack of interest says little about the suitability of annuities for any given investor, it does raise questions about the suitability of annuities as default products.
Risks of a one-size-fits-all approach. Annuities have the potential to improve outcomes for some—but not all—retirees. Imposing annuities as a universal income solution would create obstacles for the many retirees for whom annuities are not appropriate.
Irrevocability. Unengaged participants who are in QDIAs by default may find themselves owning a potentially irrevocable and costly annuity contract that they didn’t proactively select. These participants could lose control over their assets without having provided affirmative consent.
Better plan, better solution
So what can be done to improve income security for retirees? We believe retirement plan sponsors and providers can begin to address the issue together, primarily through better plan design. Potential improvements include:
- Removing age restrictions and mandatory cash-outs.
- Granting greater withdrawal flexibility for retired participants.
- Allowing for incoming rollovers.
- Offering investment options oriented to current retirees.
- Providing enhanced advice and education that may inform participants of annuitization as an option.
There isn’t one solution to the retirement income puzzle—just as there isn’t any one set of parenting techniques that will be equally effective with each of my kids. As a parent, I continually evaluate what works and what doesn’t, taking into account each child’s preferences and temperament.
At Vanguard, we continually evaluate and debate the merits of various product structures. Our deliberations are guided by one overarching question: Will it improve outcomes for investors? While annuities as a self-selected option can play a role in generating income in retirement, we believe the challenges of incorporating annuities within QDIAs are too much to overcome given the widely divergent needs of the retiree population.
As the regulatory landscape evolves, the role of annuities in defined contribution plans is likely to evolve with it. We’ll continue to share our views on lifetime income and other topics—always with an eye toward what’s best for investors.