Making retirement income work part 1: Making decisions

For years, defined contribution (DC) plans have been primarily viewed as a beneficial way for employees to save and invest for retirement. As a greater number of employees are reaching retirement age, the lens has expanded to include how DC plans can help plan participants turn their accumulated savings into sustainable income streams. Today, plan sponsors of all sizes face increasing pressure to determine whether to expand the role of their plans to include retirement income – taking into account the objectives of the plan and participant demographics.

This article is part one of a five-part Making Retirement Income Work series, covering plan sponsor and participant perspectives, legal considerations, and best practices around in-plan retirement income solutions.

All participant and plan sponsor survey references are cited from Invesco’s 2022 defined contribution research study, Show me the income, which explored large plan sponsor and participant preferences for creating retirement income.

Plan sponsors have important “retirement income” decisions to make

For the most part, plan sponsors are just beginning discussions regarding in-plan retirement income. Of those surveyed:

• More than three-quarters (77%) preferred participants leave their retirement assets in the plan when they retire, with half saying they actively encourage it.
• Partial distributions (82%) and installment payments (77%) were the top two retirement income solutions provided.

At the same time, participants increasingly want (and need) their employers to help them generate income in retirement. Nine in 10 participants surveyed said that maintaining their pre-retirement lifestyle is a primary financial goal for their DC plan savings, yet just 22% were confident that they could develop an income strategy on their own. When the time comes to start transitioning their retirement savings to income, participants lack the knowledge or experience to create a sustainable lifetime income stream.

When deciding the approach their plans should take, plan sponsors should consider designing a retirement income program and working collaboratively with their plan committees and consultants. To succeed, the program would be a combination of retirement income solutions, including:

• Flexible withdrawal options.
• Tools, including drawdown calculators.
• Non-guaranteed investments and/or guaranteed (insured) solutions.

Getting started

At a high level, there are three steps plan sponsors should take when starting the retirement income discussion:

Step 1: Review the current plan’s approach to retirement income.

As a best practice, all plan sponsors should:

• Review the plan’s current range of retirement income solutions available.
• Document the decision to make any changes (or not).

For example, a plan may already include systematic withdrawals and/or income-focused investments and may not feel the need to expand the offering. However, if, after a thorough review, a plan sponsor decides that the plan should offer new or additional retirement income solutions, they should then review and amend the plan documents accordingly.

Step 2: Amend the plan documents.

Plan amendments are considered settlor (non-fiduciary) decisions — that is, a business decision made by the plan sponsor to help achieve the plan’s objectives (e.g., increasing employee loyalty, long-term retention of employees, and/or retaining plan assets to reduce costs).

 It’s important to know 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.

Once retirement income solutions are identified, the plan documents should be reviewed with the assistance of the plan sponsor’s attorneys to determine any amendments needed to implement the decisions. For example, plan amendments could:

• Provide distribution flexibility to address retiree income preferences, such as systematic payments with the ability to change set dollar or percentage amounts if needed or access to their retirement savings via ad hoc withdrawals. In connection with that decision, the plan committee should work with the plan’s recordkeeper to ensure that it can administer flexible distributions and that participants will not be charged for withdrawals.
• Mandate changes to the investment menu. As a best practice, plan sponsors who decide to make changes to the investment menu would work collaboratively with the plan committee and consultants to determine the type of retirement income solution(s) to include, considering the needs and preferences of their participants and the plan’s objectives.

This plan amendment would be a directive to the plan’s committee and provide them with some fiduciary protection since fiduciaries are obligated to follow the terms of the plan documents unless it would be imprudent to do so.¹ However, plan sponsors could also leave the decision to the discretion of the plan committee versus providing a directive.

The plan should consider the capabilities of the plan’s service providers to administer any distribution provisions and to recordkeep the non-guaranteed investments, guaranteed (insured) solutions, and services (e.g., managed accounts) under consideration.

Step 3: Implement plan menu changes.

If the plan sponsor amends the plan document mandating changes to the investment menu, the plan committee should first determine whether it would be imprudent to follow the decisions as documented if specific direction is provided.

From a legal perspective, plan committees – as fiduciaries – are bound to follow the terms of the plan. As a result, it’s difficult to imagine that a plan provision that directs that retirement income solutions be provided on the investment menu or even that a particular type be provided would be inconsistent with the duties of prudence and loyalty. ²

The importance of (plan committee) knowledge

When making changes to the plan’s investment menu, ERISA requires that fiduciaries act “with the care, skill, prudence, and diligence” necessary to make prudent decisions, regardless of the type of retirement income solution under consideration.³ As such, ERISA’s fiduciary process requires that plan committees (and plan sponsors):

1. Obtain information that is relevant to the selection (or monitoring).
2. Assess the informa­tion.
3. Make an informed and reasoned decision based on the assessment of that information.

If plan committee members aren’t knowledgeable about a particular retirement income solution under consideration 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 committee.⁴ While input from the consultant and information from plan providers may be helpful, the decision must be made by the plan committee members, as a plan committee cannot rely “blindly” on the consultant.⁵ One exception is when a committee hires a 3(38) discretionary fiduciary as a consultant. In that case, the 3(38) fiduciary must be prudently selected and monitored by the plan committee.

Regarding guaranteed (insured) solutions, in addition to ERISA’s fiduciary process, it’s important to know that the Setting Every Community for Retirement Enhance­ment Act of 2019 (SECURE Act) has provided a fiduciary safe harbor for the selection and monitoring of insurers, as well as a defined process for the selection of the products (e.g., an annuity contract) they guarantee.

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