AllianceBernstein LP: Stable retirement income is a process, not one and done
As people live longer, they also need their retirement income to last longer. Plan sponsors are increasingly looking for solutions that provide sufficient retirement income for the greatest number of plan members, but powerful forces can deflect progress toward this goal. Even if plan members make years of regular contributions and maintain thoughtful asset allocations, an untimely market downturn or a change in interest rates as retirement approaches can be devastating.
But there is an effective solution to these pitfalls. First, you need to secure a guaranteed income stream earlier – and consistently – while working, and not shift most of the savings into a purchase at some point on the retirement threshold.
Avoiding (or accepting) risk with the help of time
People cannot predict movements in the market or in interest rates, but they can plan and protect themselves against uncertainties. The goal is to minimize the volatility of future income, and the key is to secure this by buying guaranteed income bit by bit.
Buying guaranteed income on a regular basis, ideally starting 10 to 15 years before retirement, does three important things. First, it gradually secures a level of income by locking it in, which eliminates exposure to a narrow set of market conditions (especially bad ones). Then it adds downside protection, which allows for more exposure to stocks and potential for growth closer to retirement, when most investors are typically looking to cut stocks. Finally, it provides real-time feedback to participants well in advance of retirement, so they have time to plan and adjust.
Pension assets are also exposed to the risk of return streak, where account balances suffer losses during the last years of work of participants. Without guaranteed income, sequential risk is magnified by one-time risk, which leaves a smaller stake to purchase guaranteed retirement income at the pivotal moment on the arrival of retirement.
The one-time risk has been particularly painful for investors amid the most iconic market downturns, such as the global financial crisis and more recently in the early months of the COVID-19 pandemic. As the markets fell, they cut retirement savings with them, leaving participants much less purchasing power as guaranteed rates fell, which lowered guaranteed income too low (Display).
Avoid the interest rate timing game
Interest rates are the lifeblood of almost everyone’s income calculation, and they are extremely unpredictable. By consistently buying guaranteed income in different pricing environments, participants avoid risking a lower rate (and lower income), which often happens with a one-time purchase. This risk is aggravated when the fall in guaranteed income rates corresponds to a liquidation in asset prices.
Systematic buying of guaranteed income works much like the average cost dollar (AAA), which involves buying investments at different prices gradually over time. In the case of retirement income, participants purchase income guarantees backed by an insurer at different rates in effect over time. The advantage: Lifetime income is based on a cumulative rate, rather than single point rates (Display).
“ Steady as you go ” also builds confidence
Protecting retirement income against market and interest rate declines is a good start, but the nature of purchasing guaranteed income from insurers also offers benefits.
For example, buying guaranteed income over time also builds confidence. Emotional biases seem to be swept away: for example, an annual allowance of 5% to gradually purchase a guaranteed income solution may seem more psychologically and financially feasible than the prospect of cashing out and annuity a full account balance at age 65.
It also helps the buying process to sound familiar with other programs that attendees use. Many plan members rely on periodic investments in their DC plan and believe that target date portfolios gradually reduce risk as they approach retirement. Guaranteed income solutions, especially those offered as QDIA in plan, are aligned at the heart of these other proven savings schemes.
For a worry-free retirement, we believe it makes sense to plan for a guaranteed income for life. Methodically securing this income during working years is even more prudent, as it resolves common tail risks: experiencing poor markets as retirement or retirement approaches and “living too long”. Once these issues are mastered and depending on the type of income option, other important issues can be resolved, such as preserving the value of the retirement account upon the death of a retiree or enjoying market gains.
Jennifer DeLong is Managing Director, Head Defined Contribution at AB.
Andrew Stumacher is Product Director – Custom Defined Contribution Solutions at AB.
Howard Li is a research analyst for multi-asset solutions at AB.
The opinions expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all of AB’s portfolio management teams and are subject to revision over time.
AllianceBernstein Holding LP published this content on May 21, 2021 and is solely responsible for the information contained therein. Distributed by Public, unedited and unchanged, on 21 May 2021 09:42:06 PM UTC.