Increasing and securing retirement income is “an area where Congress is willing to act,” high-profile retirement income expert Wade Pfau says, pointing to the SECURE 2.0 as proof.
The popular bipartisan legislation allows individuals to buy QLACs to satisfy all their RMD requirements up to $200,000 (indexed after 2024). It also relaxes RMD rules for retirement accounts with annuities, slowing distributions to potentially increase portfolio solvency.
While he's hesitant to call 2023 the year of retirement income, SECURE 2.0’s passing certainly brought added attention to this critical issue. It's one Pfau, Professor of Retirement Income at the American College of Financial Services, has spent his professional life addressing.
“The big change is how interest rates have normalized,” he explained. “For the past 12 years that I’ve been involved with retirement research, we could talk about a low-interest rate environment. That’s no longer true. That feeds into any approach to funding retirement, which is enhanced by higher interest rates.”
Annuities are paying more as a result, and owners can expect to spend more from investments across the board. It helps overcome some of the uncertainties created by recent market volatility.
While optimistic about prospects for widespread in-plan lifetime income adoption, he acknowledged the slow pace.
“The Secure Act will start to lay that foundation to make it easier for plan sponsors to consider annuities,” he claimed. “We still have to overcome many internal hurdles regarding understanding and concerns about the safe harbor aspect and making sure they find compliant annuities. However, I think we’ll gradually see more annuities inside employer plans.”
A reason for the slow adoption by the general public is, of course, the “A-word.” Consumers love the idea of guaranteed lifetime income, but the negative annuity connotation associated with the term presents added psychological barriers and low demand.
“Certainly, when you frame the annuity as a replacement for a traditional pension, or when you mention how Social Security is an annuity, people value and appreciate their characteristics.”
Pfau’s current research focuses on understanding how savers react to retirement income strategies and concepts.
“The big research project I’ve been part of is developing a questionnaire around four retirement income styles," He said. "It provides an agnostic, third-party approach to determining the kind of retirement strategy they might want to consider. We think about [the fact that] two-thirds of the population is looking for something beyond just an investment strategy. That opens the door for DC plan to have more than just investment-based options.”
The four retirement income styles he’s identified are:
- Total returns are the traditional diversified investment portfolio.
- Time segmentation is a bucketing approach where you invest differently based on the time horizon. It involves bonds for short-term expenses and stocks for long-term expenses.
- Income protection is protected lifetime income that covers basic spending needs before starting to invest. It’s a “floor” of lifetime income, then we can start thinking about investing for other discretionary goals.
- Risk wrap is a cousin of income protection. It takes a different perspective by having more comfort with investing for upside growth while having guardrails around the portfolio. A variable annuity benefit is an example.
“The logic of the 4% rule only focuses on spending from your investment portfolio, which only resonates with about a third of the population,” he concluded. “Traditional risk questionnaires don’t really assess the risks people are concerned about for retirement. This framework can better assess if people are worried about outliving their money, not having reserves for unanticipated spending needs, their legacy, or maximizing their retirement lifestyle.”