Making retirement income work part 2: Following a fiduciary process

With unknowns such as life spans, market returns, and unexpected expenses, planning for income in retirement is complex. How plan sponsors evolve their defined contribution (DC) plans to face these challenges involves striking the right balance – by offering a variety of retirement income solutions to help participants tailor an income strategy to meet their needs.

This article is part two of our five-part Making Retirement Income Work series, covering sponsor and participant perspectives, legal considerations, and best practices around in-plan retirement income solutions. In this series, we define retirement income solutions to include a range of flexible withdrawal options, tools, and non-guaranteed investments and/or guaranteed (insured) solutions.

Helping participants face their (income) fears

The following perspectives come from Invesco’s 2022 defined contribution research study, Show me the income, which explored large plan sponsor and participant preferences for creating retirement income. 

Surveyed participants had two intertwined fears: Outliving their retirement savings and spending too much, too soon.

• More than two-thirds (68%) of participants were worried they would run out of money in retirement, including those with higher incomes, higher DC plan assets, a defined benefit (DB) plan, or who worked with an advisor.
• Few (22%) were very confident they could create a sustainable income strategy on their own.

This presents a significant opportunity for plan sponsors, especially those who prefer participants stay in the plan when they retire. Recognizing the value their plan menu offers – including high-quality and low-cost investments and services, the avoidance of conflicts of interest, and the fiduciary oversight of the plan committees­ – almost all (96%) of the plan sponsors surveyed agreed that their plan menu should include retirement income solutions specifically designed to produce a regular stream of income for retirees.

When asked which type of retirement income solutions would be a good fit for their participants on the plan’s menu, plan sponsors believed:

Retaining plan assets

More than three-quarters (77%) of plan sponsors preferred participants leave their retirement assets in the plan when they retire, with half saying they actively encourage it. Despite this, most participants planned to roll their money out of their current DC plan into other accounts. Why? They either weren’t aware they could stay in the plan or felt their plan did not offer enough investment choice or flexibility to accommodate their unique needs in retirement. However, if the plan offered investment options designed to create a stream of income in retirement, nine in 10 (89%) participants said they would stay.

Each DC plan is different, of course, and plan sponsors should first and foremost approach their retirement income strategy considering both the plan’s objectives and the needs and preferences of its participants.

Adding retirement income solutions to the investment menu

As a best practice, plan sponsors should consider working collaboratively with their plan committees and consultants to review their plan’s current retirement income offering and document any decisions made. If a plan sponsor decides that new or additional retirement income solutions should be included, the plan sponsor should, as a settlor act, amend the plan documents accordingly.

It’s important to remember that the governing laws — the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code (IRC) — do not require that plans offer retirement income solutions. However, if a plan sponsor decides to do so, the solutions selected should be both legally compliant under ERISA and attractive to participants. This means that plan sponsors and plan committees (as fiduciaries) should be aware of not only the non-guaranteed investments and/or guaranteed (insured) solutions available in the marketplace but also which solutions can be administered by the plan’s recordkeepers and which solutions their participants would prefer.

Regardless of whether a solution under consideration is non-guaranteed or guaranteed, ERISA’s general fiduciary process should be well-known to plan committees. However, committees may be less familiar with the fiduciary processes and relief (ERISA 404(e) added by the SECURE Act) relating to the selection of insurance companies. That is, the SECURE Act provides a straightforward safe harbor for fiduciaries to select (and monitor) an insurance company and lays out the fiduciary process for selecting (and monitoring) the particular contracts (e.g., annuities) they guarantee. We outline each below.

ERISA’s general fiduciary process

As fiduciaries, plan committees must implement a process that complies with ERISA’s prudent person rule¹ in both the initial selection of an investment (or provider) and in the decision to retain that investment or provider:

• Gather and review “prudent” information. Plan committees must obtain and review the information that a “knowledgeable and prudent person” would want to review to make a particular (informed) decision. If plan committee members aren’t knowledgeable about a particular retirement income solution and/or the best way to evaluate the information gathered, the plan should engage a knowledgeable and experienced consultant to help with the analysis and advise the plan committee.
• Consider both cost and quality. While the cost of any investment or service — relative to competitive alternatives — is always important, there is no obligation to select the one with the lowest cost.² Instead, fiduciaries should consider a wide range of factors, including (but not limited to) quality, features, restrictions and/or limitations associated, and the ability of participants to understand and use the solutions (see additional requirements for guaranteed retirement income contracts in the next section).
• Make an “informed and reasoned” decision. While input from the consultant and information from the providers may be helpful, the decision must be made by the committee members, as a committee cannot rely “blindly” on a consultant.³ One exception is where a committee hires a consultant to serve as a 3(38) discretionary fiduciary for the selection and monitoring of the product or service. In that case, the 3(38) fiduciary must be prudently selected and monitored by the committee.

Guaranteed solution fiduciary process

In addition to ERISA’s general fiduciary process outlined above, it’s important to know that the Setting Every Community for Retirement Enhance­ment Act of 2019 (SECURE Act) provided a fiduciary safe harbor for the selection and monitoring of insurers, as well as a defined process for the selection of the contract (e.g., an annuity) they guarantee.⁴

In short, when it comes to selecting guaranteed solutions for the plan menu, a plan committee’s fiduciary responsibility is to make a reasonable and prudent choice that balances the needs of the par­ticipants with the terms of the contract, its cost, and the ability of the insurer to administer the product.

As a best practice, a prudent process is to:

• Review and select the type of guaranteed solution to offer. Committees and their consultants should start by assessing what is available in the market and choose the particular type of guaranteed retirement income contract – such as annuity contracts and products referred to as guaranteed minimum withdrawal benefits (GMWB) contracts – to review.⁵
• Identify insurers that offer the type of guaranteed solution the plan is considering. After deciding on the type of solution under consideration, the committee should identify insurers with a history of issuing and administrating contracts of the type selected, with a focus on those with experience in working with retirement plans.
• Follow the SECURE Act’s fiduciary safe harbor requirements. Under ERISA’s safe harbor provision added by the SECURE Act, plan sponsors, as fiduciaries, are relieved of liability for losses sustained by a participant due to an insurer’s inability to pay the benefits under the guaranteed retirement income contract selected by the plan.⁶

To obtain this safe harbor, ERISA requires only that a committee obtain specified information from the insurance company and not have any information that would cause the committee to question the representations provided by the insurance company. The safe harbor protection applies to the selection and monitoring of the insurer for such a contract but not to the contract itself.

In effect, the fiduciary responsibility has been reduced to a checklist approach, and plan sponsors are required only to obtain written representations from an insurer with respect to whether the following four points are true:⁷

1. The insurer is licensed to offer guaranteed retirement income contracts.

2. The insurer, at the time of selection and for the immediately preceding seven years:

a.  Operates under a current certificate of authority in its domiciliary state.

b.  Has filed audited financial statements in accordance with law.

c.  Maintains required regulatory reserves.

d.  Is not operating under an order of supervision, rehabilitation, or liquidation.

3. The insurer undergoes a financial examination by the insurance commissioner of its domiciliary state at least every five years.

4. The insurer agrees to notify the fiduciary of any change of circumstances that precludes making these representations.

Plan committees can look at other information (e.g., financial strength ratings) if they want to but aren’t required to do so.

• Obtain relevant information on the insured solution to consider “reasonable” contract costs. The SECURE Act requires that a fiduciary engage in a prudent process in selecting an insured solution to offer to their participants. While the safe harbor covers the selection of the insurer, plan sponsors are obligated to determine that the costs (including fees and commissions) of the contract under consideration are reasonable.⁸ A prudent process for the selection of a particular contract also involves looking at other material factors.

While the SECURE Act does not provide a simplified checklist process for assessing the cost and other features of a contract – as it does for the selection of the insurer – the Act does spell out what relevant informa­tion should be obtained and evaluated for purposes of assessing the cost and the contract:

1. The benefits provided under the contract.
2. The features of the contract.
3. The administrative services provided by the insurer under the contract.

It’s important to note that ERISA or the SECURE Act do not require plan sponsors to select the “perfect” guaranteed solution for their plans (or the one with the lowest costs); indeed, it is likely there are several insured contracts in each category that could be prudent choices for a plan.

Obtain updated representations on an annual basis. The SECURE Act recognizes ERISA’s “duty to monitor” by requiring a periodic review of the continuing appropriateness of the plan sponsor’s selection of the insurer (and the contract). For the selection of the insurer, committees can meet these requirements (and maintain the plan’s safe harbor status) by obtaining an updated set of representations from the insurer on an annual basis.

To learn more, download Fred’s retirement income legal and best practices checklist.