Firms are omitting annuities in new retirement income products

Sensing a market for flexible, pension-like retirement income products, a handful of financial services firms have released, or are about to release, in-plan income solutions that don’t include annuities.

Joining Financial Engines Inc., which released an income product in January, Dimensional Fund Advisors LP expects to launch Dimensional Managed DC, a customized managed account for employee plans, in July. And Putnam Investments is expected to announce a non-annuity retirement income solution before that.

Striving for a solution that would feel like a defined-benefit plan to an employee was what helped propel the Dimensional program.

“There are a thousand providers of DC products, but they want to maximize the amount of wealth in the accumulation period, with little focus on the actual need of providing an income stream,” said David Deming, chief executive of DFA’s Dimensional Managed DC business unit.

To provide income, the firm will craft individualized investment portfolios based on a plan participant’s responses to questions about their assets (including their defined-contribution plan balance), any applicable DB plan benefits and Social Security income. With that information, the firm will calculate a retirement income requirement and manage the employee’s assets accordingly.

Plan sponsors also can set up a default portfolio for employees who don’t provide their data.

According to DFA spokesman Austin Rosenthal, plan participants will be asked the following questions:

1. How much income do you want in retirement, drawing from Social Security, DB and DC benefits?

2. How much income do you absolutely need in retirement, again from Social Security, and funds from DB and DC plans?

3. How much are you willing to save, including the company match?

4. When do you want to retire?

At retirement, participants can let their money stay put, roll it over into an individual retirement account, draw down the assets or buy an annuity. Dimensional will charge 45 basis points for the program.

Financial Engines’ Income+ program, which charges an average fee of 50 basis points, relies on bonds to develop an income floor for participants and then sets aside some of that allocation for the optional purchase of an annuity. A portion of the portfolio also goes into equities, which FE can sell to raise its bond allocation and increase income.

Portfolios are customized for plan participants and designed for retirement payouts.

Putnam is expected to announce its version of a retirement income product shortly. Spokesman Jon Goldstein declined to comment on the company’s plans.

Driving the development of these products, executives said, is employees’ desire to recreate the certainty of a DB pension without having to fork over a large sum upon retirement to purchase an annuity.

“Most people don’t want to annuitize right at retirement,” said Kelly O’Donnell, vice president of marketing at Financial Engines. “It’s a time of the highest uncertainty. People want control and liquidity until they have a better sense of their situation.”

Employers also have resisted putting annuities into their plans, Ms. O’Donnell said. The Labor and Treasury departments are weighing how to address lifetime-income options in retirement plans and whether to permit them as qualified default investments.

To be sure, annuity-free retirement income products or strategies aren’t new. Asset Dedication LLC, for example, applies liability-driven investing techniques to its bond-based portfolios to meet retirement income goals for individuals; Unified Trust Co. NA uses a similar approach in the retirement plan arena.

Advisers who work with retirement plans note that the products are being introduced at a time when plan sponsors are seeking guidance on retirement income.

“THERE’S A DISCONNECT’

“Participants can’t figure out what the heck to do with a lump sum in retirement,” said Gary K. Allen, a principal of Prudent Investor Advisors LLC.

“There’s a disconnect between the investing side and the goal side. You have to be able to connect those two, and have the ability to say to the average person that you’re either ahead, behind or on target,” Mr. Allen said.

The managed-account solutions also give plan clients an income option that is free from single-carrier risk or insurance fees.

“I can’t recommend an annuity, for a couple of reasons,” Mr. Allen said. “When you look at transparency, it’s hard to understand the true cost of the product; the guarantee can be expensive.”

Mr. Allen said that his firm is still performing its due diligence on the Dimensional Managed DC but finds it “intriguing.”

Joe Connell, a senior retirement plan consultant at Financial Concepts, expects plan sponsors and participants to take a closer look at liability-driven solutions. Some of his firm’s clients are using Unified Trust’s Unified Plan, and about half the participants are on track to meet their retirement income goals, up from about 30% in July.

“Moving the industry average up is good, and we’d like to see 80% plus, if we can get that,” Mr. Connell said.

ROOM FOR IMPROVEMENT

Observers noted that despite the attractiveness of managed-account programs, there is still room for improvement.

“These programs are meant to go through retirement, but you’re always going to have a person who takes more or less income than expected,” Mr. Connell said.

And some participants may not be forthcoming about the assets they have outside of the plan, meaning that their portfolios might be managed too aggressively.

Maximizing participation is another area for improvement, said Greg Kasten, founder and chief executive of Unified Trust.

“If you give participants a choice on whether to sign up for the program, only 5% to 10% will bother,” he said. “Our view is: “Should you start people with the right solution, with them having to take themselves out of it?’”

E-mail Darla Mercado at [email protected].