Thursday, April 24, 2014

The Next Evolution in Defined Contribution Retirement

Welcome to this week's video blog made in cooperation with The Wealth Channel at the American College. Today I provide a discussion of the Society of Actuaries (SOA) and the Stanford Center on Longevity report written by Steve Vernon called, “The Next Evolution in Defined Contribution Retirement.” 



For email readers, the videos never show up in the email, but you can see the video by clicking here.

What now follows is not an exact transcript. It is the written version of what I meant to say above, though as I was not reading from a script, I sometimes veered away from the plan when speaking:

The Next Evolution in Defined Contribution Retirement

The Society of Actuaries (SOA) and the Stanford Center on Longevity recently released the research report, “The Next Evolution in Defined Contribution Retirement.” This report is aimed to help 401(k) and other employer savings plan participants to figure out how to build a retirement income strategy with their savings. The report was written by pension actuary and consulting research scholar for the Stanford Center on Longevity, Steve Vernon. I contributed analytic results comparing the cash flows and wealth levels supported over retirement by different “retirement income generators” in order to provide unbiased guidance about the distribution of outcomes with different retirement strategies.

In the words of Steve Vernon, “Different retirement income methods produce significantly different amounts of income depending on the method chosen. Employers can help retiring employees understand the pros and cons of each method as well as the amount of retirement income, so retiring employees can make informed decisions.”


Though the report is designed to help plan sponsors understand the outcomes of different retirement income tools on average, as well as in bad luck and good luck outcomes, I believe that anyone with an interest in building a retirement income strategy may benefit from the report. One matter which is emphasized in the report is that there may be large differences in pricing for institutional and retail retirement income solutions, such that employers can offer greater benefits to their employers through access to the cheaper institutional offerings.
 

One important point made is that 91% of plan sponsors view defined contribution pensions as savings plans, while only 9% see then as a vehicle to provide retirement income. This indicates that “pension” is not an appropriate term for what is going on. The report stresses that employers and plan sponsors must operate their plans as true retirement plans.
 

More generally, the report aims to provide education. There is no one-size-fits-all solution. Each retirement income generator provides a tradeoff between the safety of income provided and the potential for greater portfolio growth.  In particular, the work I contributed to the report shows the performance of six different retirement income generators:
 

  • Systematic withdrawals with a constant inflation-adjusted spending amount
  • Systematic withdrawals with spending equal to a constant percentage of remaining assets
  • Systematic withdrawals based on remaining life expectancies
  • An immediate inflation-adjusted income annuity
  • An immediate fixed income annuity
  • A variable annuity with a guaranteed minimum withdrawal benefit


 

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