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Is Retirement Income Next on the Agenda for 401(k) Plans?

A new report forecasts how the innovations brought on by the Pension Protection Act will continue to evolve, foreseeing a DC industry that takes on some of the traditional features of the DB industry.

In its 250th issue of The Cerulli Edge–U.S. Asset and Wealth Management Edition, Cerulli predicts that these evolutions will include plan sponsors trying to help participants more broadly with their financial lives and continued incorporation of automated features to ensure participants have sufficient savings.

“We are seeing a DC industry in which plan sponsors and consultants are taking a degree of control away from the participant with the intention of guiding plan participants to better decisions around retirement savings,” explains Bing Waldert, a managing director at Cerulli. “As part of this continued innovation, converting the 401(k) plan to an income platform is a step in taking DB market experience and applying it to the 401(k) market,” he adds.

This extends to professionally managed investments, namely target-date funds, some of which draw on liability-driven investment (LDI) techniques seen in DB plans, according to the report. The TDF “has become the workhorse of the 401(k) industry, capturing 55% of contributions and 25% of assets in 2017,” the report states. And while TDFs benefit from their simplicity, that is also a “chief criticism” of them, Cerulli notes, as they treat all participants of a single age as equal, without considering their risk tolerances, savings levels or non-401(k) assets, which could affect their ability to retire.

To that end, nearly one-quarter (23%) of asset managers identify customization at the participant level as a possible future development in the TDF industry. Cerulli suggests that, while additional customization is desirable for all participants, it is “most necessary for older investors who are closer to retirement.”

The firm warns, however, that adoption of complex investing techniques, such as LDI, makes the due diligence on these products highly challenging. Cerulli advises that asset managers must be prepared to “deliver a high level of education if they are considering launching innovative products.”

Income Options

Converting the 401(k) plan to an income platform is another major step in taking the DB market experience and applying it to the 401(k) market, the report suggests.

“This conversion can be thought of in two phases. The first is perhaps the simplest — many 401(k) plans simply are not designed for investors to flexibly take out income,” Waldert notes. “Consultants, recordkeepers, and asset managers can work with plan sponsors to redesign the plan to offer a broader set of distribution options, including partial withdrawals or regular, systematic payments.”

Cerulli warns, however, that many plan sponsors still believe that retirement income planning is the responsibility of the participant and they may not be willing to maintain fiduciary duty for a participant who no longer works for the company.

The second and “more challenging development” for evolving 401(k) plans to become an income platform is offering the correct products, according to the report. The simplest inclusion, according to Cerulli, is making retirement income options available in target-date products. The firm notes that more than one-quarter (27%) of asset managers classify a managed payout option — which aims to provide steady retirement income to plan participants by achieving specific annual payout targets — as an attribute highly likely to be included in the next generation of target-date products.

“More fraught with challenges is the inclusion of income annuities in 401(k) plans,” the firm further observes. It notes that sales abuses of retail variable and fixed-indexed annuities “have saddled all annuities with significant perception issues,” and making these products more widely available through 401(k) plans “will require significant education of plan sponsors, made more challenging by a heightened fiduciary environment.”

Moreover, while plan sponsors are more comfortable evaluating specific investments, judging the future claims paying ability of an insurance company presents new challenges, the firm notes. It adds that many in the retirement industry remain hopeful that the Department of Labor will offer plan sponsors a safe harbor for the selection of an annuity provider.

It also suggests that pending legislation, if passed, would establish clear guidelines in line with state insurance regulations that “would help plan fiduciaries choose annuity providers with the confidence that they are following these guidelines.”