VideoOver the next dozen years, baby boomers, those trend-setting, iconoclastic, and often sharp-elbowed children of the Greatest Generation, will leave the workforce in droves. Unlike their parents, many won't get a regular pension check. Enrolled predominantly in defined-contribution plans, they'll receive a lump sum of money — an approach that will benefit some but put many others in fiscal peril.
Minus the security of a check, millions of boomers will confront longevity risk — the possibility of outliving their assets. They must manage that lump sum to last a lifetime, not the easiest thing to tackle in one's 70s, 80s, and beyond. Rising concern over employees' post-retirement welfare is prompting companies, and the federal government, to help workers in their last working years make the right decisions about their future needs.
To be sure, the emphasis is on information and communication, but some companies are taking more-concrete steps. Some are tapping new annuities that essentially convert a defined-contribution plan into a defined-benefits plan. Others are pushing programs that provide for catch-up contributions to 401(k)s. And many are helping employees make better retirement decisions.
Behind these efforts is a recognition that the elimination of defined-benefits plans comes at a cost. Given economic uncertainty and the fact that people live longer, there are no guarantees that retiree money will last a lifetime. To fill the void, says Jack Brennan, CEO of Vanguard, companies need to both develop a "philosophy" about dealing with retiree money and implement programs to help employees transition from savers to spenders. "You want your employees to be successful in retirement because they will still impact morale after they are gone," he explains. But companies must be cognizant of the fiduciary responsibility embedded in offering retirement guidance — and employees must accept the risk of a possible shortfall.
Wanted: A Stream of Income
Defined-benefits plans relieved retiree apprehension in the past, with past being the operative word. In the past two years, one third of plan sponsors surveyed by the Employee Benefits Research Institute have closed or frozen their defined-benefits plans. And McKinsey & Co. estimates that by 2012, 50 to 75 percent of private-sector defined-benefits plan assets will be frozen.
In their place, of course, are defined-contribution plans, which now hold 70 percent of the $11 trillion in boomers' invested assets, according to Prudential Financial. Many retirees tend to roll over these assets into an IRA or cash in the proceeds. But a survey of 401(k) participants by Mercer indicates that 80 percent are "less than comfortable" making retirement investment decisions. And 70 percent of preretirees in a Prudential Financial survey wished they had an "autopilot plan" defaulting them into a lifetime income program.
Such insecurities have led to the introduction of products such as target-age or life-cycle funds, which automatically rebalance 401(k)s, as well as a renewed interest in annuities. In fact, in the last year providers have taken the tarnish off the latter, restoring some luster to a much-maligned product. Whereas yesterday's annuities stopped payment upon death, for example, newer versions allow beneficiaries to receive payments. And employers are helping by leveraging their clout, offering annuities as a company benefit. "You have a lot more buying power if you're General Motors rather than John Smith," says George Castineiras, senior vice president at Prudential Financial.
Medical Associates, an 80-year-old multispecialty clinic, found a solution in IncomeFlex, which it introduced last year. Sold by Prudential Financial, the annuity not only provides a steady income for life, it guarantees that the notional value of an employee's 401(k) assets — or as much as they invest — will not be reduced by market performance. When a participant retires, he is guaranteed a steady lifetime annual withdrawal based on the highest of three values: the market value, the highest value of the assets on the person's previous birthdays, or the 5 percent income growth value. In return, the insurer will guarantee a 5 percent minimum withdrawal, starting at 65, for the rest of the retiree's life.
The plan was introduced to the 400 Medical Associates employees past the age of 50. And of the 53 who initially signed on, says CFO Jeff Gonner, most said "they'd rather have Prudential be in charge of their investments than themselves." The employees didn't go into the plan half-heartedly, either. "While they could have put a conservative percentage in the Income-Flex option, they put in 96 percent on average," the CFO notes.
Despite the improvements, annuities aren't without both downside and risk. The downside to annuities is their cost. Employees pay an annual premium, 95 basis points in this case — or nearly one percent of assets — to Prudential to manage their money. Risks include the possibility of inflation topping 4 or 5 percent or, says Joseph S. Adams, a partner at McDermott Will & Emery, "if the provider goes under." In that case, there are state insurer guaranty funds to pick up the payments. "However, there is always the risk the guaranty funds may not be able to provide 100 cents on the dollar if numerous insurers file for bankruptcy at the same time."
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