The 401(k) started as a tax-deferred supplemental savings plan over 40 years ago. Since that time, industry professionals have fashioned it as a retirement plan, yet participant education mostly emphasized contributions and wealth accumulation. What’s been missing? Income.
That’s about to change. Since the enactment of the SECURE Act on December 20, 2019, industry observers have focused on the annuity safe-harbor for Defined Contribution (DC) plan sponsors. But we believe the Act’s requirement for DC plans to make retirement income projections may become more significant because of its potential to change investment preferences.
Catalyst for Change
The most crucial consideration in retirement income planning is an unknown time horizon, which raises the danger of outliving your assets, or longevity risk. We expect that the new required income projections will bring longevity risk to the forefront because it makes a tangible link between assets and a retirement income.
The potential for disappointment among your participants is high. Some may be very surprised to learn that their balances generate so little in lifetime income. Others may be relieved, if the income is high enough. But for all participants, connecting assets to future income needs accentuates different risks and the potential to change investment preferences.
“The potential for disappointment
among your participants is high.”
Retirement Income Risks Gain Visibility
As participants begin matching assets to future income needs, the juxtaposition between longevity risk and the market risks in their diversified portfolios will become more evident. The two unknowns present a new challenge: “How do I generate strong enough returns to fund years of retirement expenses while avoiding market risks that undermine that objective?” It’s now a battle between longevity and market risks (Figure 1).
Solutions for addressing longevity risk require annuities or investments with enough capital growth to fund retirement expenses. But capital growth invites market risk, requiring investments that also reduce the volatility and capital losses that harm retirement funding.
Address the Balancing Act
Addressing this new balancing act is no picnic for retirement income investors. We can shed more light on these opposing risks and DC plan options that attempt to solve this challenge – contact us today.
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