It’s not a true cost-of-living adjustment, though, because it doesn’t hedge the risk of unexpectedly high inflation that can erode living standards the most. This approach essentially shifts income from earlier retirement years to later retirement years in order to create a self-financed buffer for expected inflation. Riders typically increase income payments by a fixed 2% per year, while at the same time reducing the participant’s initial payout amount. Participants can boost fixed-annuity income later in life by adding a rider with a cost-of-living adjustment. Implicit Cost-Inflation : Fixed-annuity payments are typically not linked to inflation dynamics, which can erode the buying power of income over time. This exchange sacrifices growth opportunity compared with a GLWB, where participants keep their assets, including growth investments-with potential gains raising the level of lifetime income. With a fixed annuity, a participant surrenders assets up front, essentially passing those growth assets to the insurer in exchange for receiving fixed payments like those of a long-term bond.
That makes it vital to maintain enough exposure to growth investments, such as stocks-even during retirement. Implicit Cost-Growth Opportunity: When participants retire, they expect to live for decades.
THE ULTIMATE INTERNET ICEBERG FULL
Understanding a lifetime income solution’s full cost requires analyzing how design influences potential outcomes-and the ultimate value to participants. This distinction prevents a direct comparison of explicit fees. A fixed annuity requires participants to surrender all assets up front in exchange for lifetime income, so annual fees typically don’t apply. These fees cover the insurance company’s obligation to continue paying lifetime income if a participant’s account assets run out. To illustrate how design distinctions can influence costs, let’s briefly compare two lifetime income approaches: a GLWB (typically accompanied by a target-date portfolio) and a fixed annuity.Įxplicit Fees: With a GLWB contract, participants keep ownership of their assets, paying an explicit annual management fee and insurance premium. What Influences the Cost of Lifetime Income Solutions? Because the SECURE Act requires plan sponsors to prudently evaluate the costs and benefits of lifetime income solutions, it’s critical to accurately measure all costs-and resources are available to help. So, the total cost of lifetime income solutions can look like an iceberg: some costs are explicitly visible above the surface, but what’s under the water matters, too. Another implicit cost is the spread: the difference between what an insurer earns on assets that participants surrender up front and the lower amount the insurer pays to the participant in guaranteed income. For example, one implicit cost is forgoing long-term growth potential when surrendering assets to buy a fixed annuity. Implicit costs aren’t listed like stated fees-they’re inherent costs stemming from the way a solution is designed. What’s the difference between explicit fees and implicit costs?Īn explicit fee is a stated charge to a participant…like an expense ratio for an investment option. To make that determination, the sponsor must assess benefits versus explicit fees and implicit costs-from the individual participant’s perspective. Whether it’s a managed-drawdown option, immediate annuity, deferred fixed annuity, qualified longevity annuity contract (QLAC) or guaranteed lifetime withdrawal benefit (GLWB), each plan sponsor must choose the option that provides the best value to participants. But with many options to choose from, plan sponsors need to evaluate a wide range of choices-each with its own structure, benefits and costs.Īssessing Costs: Looking Beneath the Surface The SECURE Act has made plan sponsors more comfortable as fiduciaries in taking action to evaluate and implement lifetime income solutions. More than half of DC plan sponsors want such a solution, too. Lifetime income solutions are high on the wish lists of defined contribution (DC) plan participants, with the certainty of a guaranteed lifetime income stream ranking as the top feature in our surveys over the past decade.
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