The U.S. private defined contribution (DC) market is evolving from a supplemental savings vehicle to a primary retirement vehicle, supporting employees throughout their retirement. This shift, along with major retirement legislation, is leading to innovations that address retirement readiness as well as longevity risk.
To stay relevant, plan sponsors and their advisors must evaluate the latest market trends and developments to ensure that they continue offering competitive retirement benefits that meet the diverse needs and expectations of their employees and retirees.
1. Need for Inflation Protection
Inflation, both domestically and abroad, remains stubbornly high. While inflation will likely decline due to the Federal Reserve's monetary policy and as transitory issues impacting supply chains are resolved, we expect it will remain elevated relative to the level experienced in the decades before the pandemic.
In such a scenario, asset class correlations may be less diversifying than they have been in the past, as traditional stock and bond portfolios tend to do poorly amid high or rising inflation, this calls for the following considerations:
- Supplement core investment options utilized by "do-it-myself" participants with a multi-asset inflation hedging option with exposures diversified across a basket of real assets such as REITs, TIPS, commodities and gold. These assets respond differently to inflation depending upon the specific inflationary drivers, enhancing diversity relative to a traditional stock and bond portfolio. Managed accounts can be helpful with the appropriate sizing of the allocation to real assets.
- Annuities can be used as a replacement for a portion of traditional fixed income allocation to enhance income and protect retirees from an income "tail risk" in an environment, like today, where bonds underperform and produce negative real returns after accounting for inflation.Annuities are expected to play a more prominent role as part of professionally managed allocations, as the industry moves to address common challenges associated with retail annuities.
2. Evolution of Lifetime Income Solutions
Lifetime income products have been available for DC plan sponsors for some time, but participants' utilization has generally been very low. The passing of the Secure Act in 2019 provided fiduciaries new safe harbor provisions when selecting an insurance provider and gave participants new portability provisions that allowed them to transfer a 401(k) annuity to a different workplace plan or IRA without paying surrender charges and penalties.
This has spurred an unprecedented wave of product innovation, including embedding annuities as part of target date funds with the option — not the obligation — to annuitize a portion of a participant's balance.
This approach builds on the success of target date funds as the Qualified Default Investment Alternative (QDIA) and would likely lead to higher annuitization rates. Additionally, a plan sponsor would benefit from delegating the fiduciary duty of selecting and monitoring the insurance provider as this role would be undertaken by the target date fund provider.
An alternative approach is to offer in-plan annuities on a standalone basis and pair them with a managed accounts program that can help participants determine the optimal amount of annuitization. Managed accounts are rapidly evolving to account for guaranteed income offerings and have an advantage over target-date funds through their ability to customize a participant's portfolio and level of annuitization based on their specific financial circumstances and objectives.
Participants closer to, and in, retirement are more likely to engage with managed accounts and have a higher need for personalization.
Plan sponsors will need to be aware of the increased cost and complexity associated with the lifetime income products, along with myriad other considerations. Recordkeeper integration and participant experience will be key to the success of the program.
Currently, the portability of these solutions between recordkeepers is limited; however, this is expected to change as the middleware infrastructure between plan sponsors, recordkeepers and insurance providers is further developed.
