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Lifetime Income Solutions as a Qualified Default Investment Alternative (QDIA)

Statement of the Investment Company Institute

Sarah Holden
Senior Director, Retirement and Investor Research
and
Shannon Salinas
Assistant General Counsel, Retirement Policy

2018 ERISA Advisory Council

August 15, 2018
Washington, DC

As prepared for delivery. ICI's written testimony from the hearing is also available.

ICI would like to thank the ERISA Advisory Council for the invitation to appear here today.

The Council is considering whether to identify the need for lifetime income as an important public policy issue and whether it should advise the Department of Labor to support initiatives that could lead to broader use of lifetime income options in defined contribution (DC) plans.

The underlying premise of the Council’s focus on promoting lifetime income in DC plans is that most Americans are under-annuitized and that promoting annuitization of retirement account balances would benefit American retirees.

The key takeaway from the first part of our testimony is that research does not support the premise that American workers need more of their retirement income in the form of an annuity.

The underlying concern about under-annuitization rests in part on research which uses simplified economic models to predict that individuals should annuitize all wealth at retirement.

This resulted in an “annuity puzzle” because, contrary to these predictions, few households choose to purchase annuities.

However, a long line of ensuing research has pointed out that early models oversimplified the choices that households face and the so-called “annuity puzzle” is more a reflection of the limitations of the models than of poor decision-making by households.

Additionally, data reflecting actual US experience find that US households generally steward their retirement accumulations to and through retirement and appreciate the flexibility of having control over both income and assets, often citing concern about unexpected needs.

Our written testimony summarizes seven main observations from the relevant research and data:

First, retirement resources, which allow workers to reallocate lifetime resources from their working years to their retired years, should be thought of comprehensively.

Rather than a three-legged stool, retirement resources should be thought of as a five-layer pyramid, with Social Security, homeownership, employer-sponsored retirement plans, individual retirement accounts (IRAs), and other assets, as the layers.

Before contemplating whether American workers should annuitize a portion of their DC plan accumulations, it is important to recognize that the concept of annuitization is broader than just annuity products, and a saver’s decision regarding annuitization requires consideration of all household resources.

  • Social Security benefits and DB plan benefits that are not paid out as a lump sum provide monthly payments for life.
  • Homeownership also represents an annuitized asset in that it allows retirees to live in their homes rent-free, reducing the amount of monthly income retirees need to generate. 
  • Within employer-sponsored plans there may be multiple accumulations to manage. US workers change jobs over their careers and most workers across all age groups have low tenures at their current employers, which means the DC plan balance at any given employer is just one component of a household’s retirement resources.

Second, the US retirement resource pyramid has a strong annuitized base, Social Security, which is progressive and provides high replacement rates for lower-income workers.

Third, when including all retirement resources, it is clear that US households are highly annuitized outside their DC plans.

This is true whether one looks at household wealth or retiree income measures.

A comprehensive balance sheet of households approaching retirement age reveals that 94 percent of comprehensive wealth of the lowest wealth quintile is annuitized assets—that is, Social Security wealth, net housing wealth, and DB pension benefit wealth.

For the highest wealth quintile, half of their comprehensive wealth is annuitized.

Tax data show that most taxpayers’ non-labor income is highly annuitized in the third year after claiming Social Security.

  • For the lowest income quintile, 71 percent of non-labor income is Social Security benefit payments. Moving up the income distribution, this share falls to 38 percent for the fourth income quintile.
  • In addition to Social Security, for the lowest income quintile, 18 percent of non-labor income is DB, DC, and annuity payments. This share rises to 37 percent for the fourth income quintile.

Because of these high levels of annuitization of wealth and income, it is rational for households to seek to keep account balances handy for times of unanticipated need.

Fourth, individuals entering retirement who need more annuity income should first consider delaying claiming Social Security before purchasing an annuity in the market.

Review of the research on this topic finds:

  • Delaying claiming increases annual Social Security benefits.
  • While market-priced annuities are not actuarially fair, Social Security benefit increases for delayed claiming are designed to be actuarially fair for the average worker.  
  • Delayed Social Security claiming maximizes annuity income.

Policymakers considering rule changes to promote annuitization within DC plans must be mindful of the impact of such changes on the resources that would be available to households to allow them to delay Social Security claiming.

Fifth, in addition to regular income, most households want access to resources in times of unexpected need, and required minimum distributions (RMDs) are a responsible way to produce a lifetime income stream while still maintaining access to the account balance.

From time to time, households may need to replace an appliance, fix a car, or pay for an unexpected hospital bill. In those cases, it may be better to have liquid savings than to go into debt and pay it off monthly.

Household surveys find that retirees place value on having access to a balance that is available for such emergencies and large expenditures. And 42 percent of US households aged 65 or older indicate that saving for liquidity is their primary savings goal.   

Sixth, most retirement savers steward their accumulations to and through retirement.

More than two-thirds of DC plan participants across all age groups leaving their employers in 2017 preserved their retirement assets. As a result, 95 percent of assets were preserved.

Participants who choose to roll over into IRAs have researched the decision. Often, households are seeking to consolidate and keep track of assets, which makes sense given the mobility of the US workforce.

IRA investors spend down their balances responsibly:

  • Tax data, recordkeeper data, and survey data find that few IRA investors withdraw money from their IRAs in any given year.
  • Eighty-one percent of traditional IRA–owning households that make withdrawals are retired.
  • And 71 percent of traditional IRA–owning households’ withdrawals were calculated meet the RMD.

Finally, households having financial difficulties in retirement typically had similar difficulties while working, and promoting annuitization will not solve the problem of limited lifetime resources.

Part of the goal of promoting annuities in DC plans appears to be motivated by a concern that retirees will spend down balances too quickly or irresponsibly.

Recent academic research finds that retired households who have low wealth at the end of life typically entered retirement with low wealth.

As documented in detail in our written statement, these seven observations indicate that US households are not under-annuitized and therefore that annuitization does not need to be given special treatment in DC plans.

And, now my colleague Shannon Salinas will summarize the second part of our written statement, addressing specific proposals that are before the Council.


Thank you, Sarah, and let me add my thanks to the Council for inviting ICI to share its views on these important issues.

The Council is considering ideas to foster greater use of annuities in defined contribution retirement plans.  We would like to comment on two heavily promoted ideas:

  • The first would modify the QDIA safe harbor to limit the right of participants who have been defaulted into annuities to transfer out of those products; and
  • The second would require plan benefit statements to include a lifetime income illustration based on an annuity calculation.

Neither of these proposals would advance the goal that the Council shares with all of us in the retirement industry—promoting the interests of retirement savers. 

Instead, these proposals are unnecessary; they will not serve the policy goals that Congress and the Department of Labor have long pursued in the design and regulation of DC plans; and they could do more harm than good to plan participants. 

We urge the Council to reject both ideas.

Let me start with the proposal to create a special exception from the QDIA transferability requirement to benefit annuities.

The QDIA safe harbor was a dramatic change in the law governing participant-directed defined contribution plans.  It was designed as a creative solution to a unique problem. 

Congress and the Department wanted plans and participants to benefit from the enhanced participation and saving that could result from automatic enrollment. The Department also wanted to encourage employers to choose more appropriate default investments, rather than the conservative money market or stable value funds that were the typical defaults at the time.

The QDIA rule created a safe harbor under ERISA Section 404(c).  It provides fiduciary relief for plans that default automatically enrolled participants into a comprehensive, diversified vehicle appropriate for long-term saving.

The QDIA rule includes several conditions designed to protect participants whose assets are invested by default.  One of the most important requirements is transferability and liquidity—giving defaulted participants an opportunity to direct their investments out of the QDIA at least once in any three-month period.

This condition preserves participant direction and choice—two important tenets of 404(c).  The QDIA safe harbor recognizes that today’s auto-enrolled workers, placed in a default investment, may become tomorrow’s active participants, pursuing their own retirement savings strategy among their plans’ options.  The QDIA’s transferability requirement ensures those workers will have such opportunities.

The proposal to modify the QDIA would significantly weaken that requirement—but only for one class of products, annuities.  This change would not serve the interests of retirement savers, for the following three reasons:

First, proponents want this amendment to promote a specific product—one that is not a necessary component of most savers’ retirement portfolios, as shown by the research Sarah just described.

Second, the modification would remove participants’ ability to exercise choice and direction for their retirement savings.  Simply put, the idea that participants defaulted into an investment would be unable to move out of that investment for years turns the principles of the QDIA safe harbor on its head and makes a mockery of the concept of “participant direction.”

Relaxing the transferability requirement would be especially problematic for defaults into annuities.  Even if participants are comfortable with an initial default into an annuity, changes in their financial status or changes in their health could prompt them to want to move out of the annuity—only to find that they are locked in.

There is also the risk that an annuity provider’s financial condition could deteriorate, rendering it unable to make future payments. 

As annuity supporters acknowledge, plan sponsors have difficulty determining the financial soundness of a provider.  Adopting both the QDIA proposal and the annuity selection proposal under the Council’s consideration would effectively transfer that burden to participants.  This is hardly in participants’ best interests.

Third, the proposed modification to the QDIA safe harbor is unnecessary. 

The current safe harbor is product-neutral, and the DOL has already clarified multiple times that annuities can be incorporated into a target-date fund or other QDIA—so long as the resulting investment provides all the necessary safeguards for participants, including transferability. 

The Council should stand behind that principle—and should not support any additional restrictions on participants’ ability to transfer out of a QDIA.

Briefly, I would also like to address the issue of lifetime income illustrations. 

ICI strongly supports voluntarily providing participants with illustrations and tools to help them determine whether their savings are on track toward retirement security.  But the Department should not prescribe a single method for lifetime income estimates.

In some cases, the variability of annuity-based estimates could cause confusion for participants.  Annuity calculations are highly sensitive to assumptions and changes in interest rates.  As our written statement illustrates, a worker who started saving in 1975 and retired in 2015 would have seen her income projections fall from $1,100 a month during the record-high interest rates of 1979 to less than $500 a month in 2015’s low-rate environment.  That’s a decline of 55 percent.  It’s hard to see how such a variable income projection would advance her retirement planning.

Fortunately, plan service providers have responded to the demand for planning tools with a wide range of illustrations, on-line tools, and calculators that help savers understand their individual circumstances and enhance their planning.  These innovations should be encouraged—not supplanted by a new mandate for annuity-based income illustrations.

ICI has suggested language that the Department could use to expand the guidance in Interpretative Bulletin 96-1 to clarify that information on distribution options and retirement income qualifies as participant education, not investment advice.  This relatively simple change would ensure continued development and innovation while protecting the interests of participants.

Thank you for your attention, and Sarah and I look forward to your questions.