The tepid take-up rates of annuity offerings in defined contribution plans are well-chronicled — but if that were to change, how much difference might it make?
That’s the focus of a new report by the non-partisan “fact tank” Employee Benefit Research Institute, which takes a look at one of the newest product entrants in the space, the Qualifying Longevity Annuity Contract, or QLAC, and its potential impact on shoring up retirement income security.
The QLAC — an insurance product designed to provide monthly benefits, but at an advanced retirement age (say 80, or 85), rather than at the point of retirement — has drawn some interest in recent years, as well as the support of regulators who, in 2014, issued final rules creating a qualifying longevity annuity contract (QLAC) that would be exempt from the requirement that distributions from defined contribution plans and individual retirement accounts would typically need to begin by age 70-1/2.
QLACs can be offered for a small fraction of the cost for a similar monthly benefit through a single premium immediate annuity (since, in the absence of some other insurance product, the individual is effectively absorbing the risk/cost during the deferral period), and many believe that this type of product would at least partially mitigate the individual’s reluctance to surrender control over a large portion of their defined contribution and/or IRA balances at retirement age.
The EBRI analysis models two scenarios under which QLACs could be utilized as part of a 401(k) plan. The first assumes that 15% of the 401(k) balance with the current employer is converted to a QLAC premium (in the analysis the risk of purchasing when interest rates are low is mitigated by using a 10-year ladder of purchases based on 1.5% of the 401(k) balance each year from ages 55-64). The second assumes that (some) plan sponsors would be willing to convert the accumulated value of their 401(k) contributions to a QLAC purchase at retirement age on either an opt-in or opt-out basis for the employees.
The conclusion? In the report, EBRI Research Director Jack VanDerhei concludes that “…even at today’s historically low interest rates, the use of QLACs, through the transfer of longevity risk to the insurer, provides a significant increase in retirement readiness for the longest-lived quartile with only a small reduction for the general population.”
What’s significant? Well, under the first scenario outlined above, the EBRI analysis finds that the increase in retirement readiness ratings (RRR) for those in the longest relative longevity quartile (those estimated to live longest) among Gen Xers is 3.5%, for Late Boomers 2.9%, and for so-called “Early” Boomers 1.9%. The report also explains that the larger percent increases for the younger cohorts are largely a function of having the larger 401(k) balances as a multiple of earnings.
Interest Rate Impact
Of course, those results are based on today’s “historically low” interest rates — things improve if those interest rate assumptions rise (and the associated premia decline). A 20% decrease in premium rates increases the range of RRR increases to 3.2% for Early Boomers and 5.3% for Gen Xers, while a 30% decrease in premium rates increases the range of RRR increases to 4.5% even for Early Boomers, and 6.7% for Gen Xers.
Another caution: EBRI also considered the impact across all households (including those who do not live to age 85 and thus do not receive any income benefits for their QLAC premia), and then the results were found to be small, all less than 1% in absolute value). When a 30% premia decrease was assumed, the change in RRR varied from a decrease of 0.1% for Early Boomers to an increase of just 0.4% for Gen Xers.
Considering the second alternative (where employers converted some of their contributions to a QLAC at the worker’s retirement age), EBRI found that the increase in RRR (compared to the baseline of no QLACs) for Early Boomers in the longest relative longevity quartile with a QLAC was 6.7%, increasing to 7.3% for Late Boomers and 8.7% for Gen Xers, with even better results when decreases in premium rates were factored in.
The differences modeled by EBRI are, of course, hypothetical. Additionally, we do not know what, if any impact, the return of a more typical interest rate regime might have on actual take-up rates by individuals (and plan sponsors).
However, absent an improvement in availability and take up rates (and EBRI has previously reported that differences in age, income and expected longevity seem to influence interest in this product), it may not make any difference at all.