Robert Powell’s Retirement Portfolio: The retirement crisis: where do we stand?
What were the most significant developments in the world of retirement in 2021? What laws affected, for the better, those saving for or living in retirement? What products and investments now have the possibility of lessening the retirement crisis?
Here’s what experts had to say.
Translating assets into income
Income has always been the focus of defined-benefit plans and Social Security benefits. But that’s not been the case for defined-contribution plans such as the 401(k), which started when Congress passed the Revenue Act of 1978. With 401(k) plans, the focus has always been on assets and not income, on how much a plan participant has accumulated as opposed to how much income their nest egg can produce.
But that changed considerably in 2021, according to Arun Muralidhar, a founder of AlphaEngine Global Investment Solutions.
“At a high-level theme, it is the recognition in the industry that for defined-contribution plans, retirement income — as opposed to assets under management in your retirement account — is what should be focused and reported on,” he said.
And that recognition, according to Muralidhar, came from many quarters, including legislation such as the SECURE Act, which requires that 401(k) and similar defined contribution workplace retirement plans provide “lifetime income illustrations”—to participants, and new product designs and discussions from many vendors, including Dimensional Fund Advisors, PIMCO, and T. Rowe Price.
The SECURE Act also lets 401(k) plans offer a “guaranteed retirement income contract” or GRIC to plan participants…as a default.
“The most significant retirement event of 2021 was the advent of the first generation of defined-contribution plans that include a default to guaranteed lifetime income among major investment companies,” said Michael Finke, a professor and Frank M. Engle Chair of Economic Security at the American College of Financial Services.
These products, said Finke, harness the power of defaults, which are now the dominant form of investment within defined-contribution plans, to provide a floor of pension-like lifetime income a retiree can use to supplement income from Social Security.
“We know that the biggest problem with traditional target-date defaults is the lack of clarity about how much a retiree can safely spend each month in retirement, and a lack of protection against the risk of outliving savings,” he said. “Partial lifetime income defaults take the best of the old pension system and blend it with traditional investments that can be used for growth or liquidity. One day we’ll look back on the current landscape of default investments and wonder how we expected average employees to build a lifestyle from an investment portfolio on their own.”
David Blanchett, head of retirement research at QMA, expects more and more firms to do launch add annuities to 401(k) plans in 2022. “I think annuities definitely can help people if it’s the right product and situation, and especially these newer products given the overall quality of the products,” he said.
Speaking of annuities, Wade Pfau, a professor at the American College, also noted two developments that he was involved in worth mentioning. One was the launch of Retirement Income Style Awareness Profile or RISA for short. RISA is a financial personality assessment that ultimately identifies your preference for a retirement income strategy and implementation approach.
And the other is the launch of RetireOne’s contingent deferred annuity or CDA, which, according to the company, is a tool for individual investors that allows them to create a structure that acts like a “personal pension plus” by covering retail ETF and mutual fund investments with insurance protections in IRAs, Roth IRAs or brokerage accounts. These protections, according to RetireOne, allow individual investors to insure their retirement savings against sequence of returns risk, market risk, and longevity risk.
SeLFIES become a reality…in Brazil
Robert Merton, a Nobel Prize winner and professor at the MIT Sloan School of Management, and Muralidhar have been asking governments to no avail to issue a new type of bond called SeLFIES that they believe addresses the problems associated with individuals increasingly being asked to take responsibility for their own retirement planning (how much to save, how to invest, and how to decumulate one’s portfolio at retirement) when a majority of these individuals are financially unsophisticated.
The SeLFIES (short for Standard-of-Living indexed, Forward-starting, Income-only Securities) bond is a single, liquid, low-cost, low-risk instrument, easy-to-understand for even the most financially unsophisticated individual, because it embeds accumulation, decumulation, compounding and inflation-adjustments, according to Merton and Muralidhar.
SeLFIES, say those fond of the concept, represent the best of Social Security, a defined-benefit plan, a defined-contribution plan, a zero-coupon bond, a Treasury Inflation-Protected Security (TIPS) and a deferred-income annuity, and among other things, ensures longevity risk protection and hedges standard-of-living risk, which is a key unmanaged risk globally today.
And now, at long last, Brazil has decided to issue SeLFIES in 2022. “This is a massive step as it shows that governments are getting serious about retirement safety and doing something to ensure effective retirement income,” said Muralidhar. “Hopefully, other countries follow their lead.”
ESG in 401(k) plans
In 2020, the Trump administration’s Labor Department put the kibosh on 401(k) plans adding, despite their growing popularity, ESG funds as an investment option for plan participants. Fast forward to 2021 and much has changed. “In a significant reversal, the Labor Department has corrected the previous administration’s overreach regarding the use of ESG funds in retirement plans,” said Tony Davidow, president and founder of T. Davidow Consulting and author of Goals-based Investing.
The proposed rule, Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights, recognizes the importance of including ESG funds and allowing them to vote proxies, said Davidow.
“While there is an industrywide need for better education regarding ESG/sustainable investing, to preclude them in retirement plans, or to place a higher fiduciary burden would seem imprudent,” said Davidow. “There is ample historical data showing that many ESG funds have outperformed non-ESG funds. This is due in part to the value of the E, S, & G pillars in screening out ‘bad’ companies and identifying ‘good’ companies.”
Of course, not everyone is fond of ESG funds.
“There are too many investors blindly following the ESG trend,” said Robert Huebscher, the CEO of Advisor Perspectives. And Michael Edesess, in his article, Stop the ESG Nonsense, explains three serious problems with ESG investing:
it won’t really accomplish its claimed objectives;
it will give the pursuit of those objectives a bad name by undermining the seriousness of their pursuit;
and most important, it creates an industry of well-compensated but Mickey Mouse jobs paid for by increased fees for investment management, drawing people away from much more important work in which they should be engaged.
Auto transfer of 401(k) plans
Some years ago, when Tony Webb was a senior research economist at the Center for Retirement Research at Boston College, he met Spencer Williams and Tom Johnson of Retirement Clearinghouse.
“They had an idea for automating the transfer of 401(k) plan balances from one plan to another,” said Webb, who is now an affiliated researcher with the Schwartz Center for Economic Policy Analysis at The New School. “They really were the men in white hats, trying to do good.”
“I wished them luck but was certain they would never overcome the myriad technical and regulatory barriers to implementation,” said Webb. “They did, and Vanguard adopted their solution during 2021.”
“This is a big win for small and financially unsophisticated savers who would otherwise cash out or forget about their savings,” said Webb.
By way of background, the Employee Benefit Research Institute estimated that $92.4 billion was lost in 2015 due to leakages from cash-outs, representing a serious problem that affects the potential of 401(k) plans to produce adequate income replacement in retirement.
Do RMDs Matter?
In 2021, Olivia Mitchell, the executive director of the Pension Research Council at the Wharton School of the University of Pennsylvania, became quite interested in the impact of raising the required minimum distribution or RMD age.
And what she and her fellow researchers found was this: “Delaying the RMD from 70 to 72 or even age 75, changes the timing of tax payments, but it hardly affects overall tax payments over the remaining life cycle.”
This, they wrote, is due to a “catch up” effect, where lower tax payments early on in retirement are offset by higher tax payments later, due to having higher 401(k) values and larger taxable withdrawals.
“Under a progressive RMD, households intending to leave a bequest end up paying less tax over their lifetimes,” Mitchell and her colleagues wrote. “Instead, they use the $100,000 exemption limit to transfer wealth to the next generation without fear of penalty taxes. This leads to lower tax payments, especially for the wealthiest 1% of taxpayers.”
In 2021, the Society of Actuaries published three noteworthy reports that provide perspectives on the impact of the pandemic on Americans. Those include
Financial Perspectives on Aging and Retirement Across the Generations
Financial Perspectives on Aging and Retirement Across the Generations – Report on Race and Ethnicity
Exploring Financial Fragility Across Generations, Race and Ethnicity
What were some of the major findings from those reports?
35% of workers have changed or considered changing when they plan to retire as a result of COVID‐19 with most of these respondents delaying their retirement.
The COVID-19 pandemic has prompted three in 10 Black/African-Americans and almost four in 10 Asian American and Hispanic/Latino respondents to change or consider changing when they will retire.
Hispanic/Latino respondents report the highest levels of retirement-related concern, mostly worrying about not having enough money to pay for adequate healthcare, not being able to manage their finances, not being able to maintain their standard of living, and the value of their savings/investments not keeping up with inflation.
Concerns about the effect of climate change threatening retirement security are highest among Hispanic/Latino respondents.
There are dramatic differences in financial priorities, concerns, planning behavior and the impact of the pandemic by different levels of financial fragility. Those more likely to be fragile include millennials; Generation X; females; those single, divorced or living with a partner; and, not surprisingly, individuals with lower income and savings levels. The study also finds significant differences between racial and ethnic groups, with Hispanic/Latinos having higher shares with high financial fragility.
Read:Employee Benefits After COVID-19, which provides a path for thinking about how employee benefits may change in the future.