The shift from defined benefit to defined contribution plans as the primary savings vehicle for Americans has been talked about for so long that many may be numb to it. But if you look closely, what was once a marathon process that took decades to fully materialize has nearly run its course.
At the turn of this century, 55% of retirees had a pension benefit. By 2020, while that number had declined precipitously, a still meaningful 21% of retirees could rely on the stable income that a defined benefit plan provided. By 2030, this is expected to drop further to 5%. In other words, by the end of this decade – and we’re nearly half way through it -- pensions will effectively be a thing of the past.
Figure 1: Increasing Need for Income Solutions Given Decline of DB Plans and Longer Life Expectancies
As longer life expectancy and disappearing pensions increase urgency, DC plan sponsors and intermediaries have begun to rigorously analyze guaranteed income solutions to support participants efficiently spending their assets in retirement without fear of running out of money. But from the employer’s perspective, adding a lifetime income solution requires a number of considerations beyond the income vehicle itself. Retirement Income is a new category and benchmarking income solutions amidst the broad range of objectives and product structures can be challenging. Here we offer why we believe Target Date Funds are the proper foundation, and why the evaluating the right glidepath plays a key role in maximizing the value that guaranteed income can offer.
The most -- some might say only -- effective means to drive adoption of defined contribution investment options is through the plan default. Over 80% of plan participants today use Target Date Funds as their wealth accumulation vehicle. Target Date Funds provide a low-touch, professionally managed approach to building wealth over long time horizons. While programs that offer annuity purchases through the core menu or brokerage window are helpful in providing plan participants with choice, historical participant behavior suggests that very few exercise that flexibility and fewer have the knowledge necessary to make an optimal decision around guaranteed income purchase. Building off of the Target Date framework to offer participants the structured choice to convert to a lifetime income stream is likely the most effective and seamless means to meaningfully impact participant adoption, and ultimately improve outcomes.
For an income solution to work, it needs to add value without compromising the many things that Target Date Funds do well – simplicity, efficiency and (in most cases) liquidity. How each manager addresses liquidity, portability, costs and the participant experience will be key differentiators in which income solutions gain traction. But the traditional measures of comparison should not be lost in this process. A well-designed glidepath will continue to be key to supporting participants throughout retirement. To highlight this, we offer three key questions that investment decision makers should ask as they consider default solutions with guaranteed income.
The State Street Target Retirement glidepath uses a strategic, index-based approach to asset allocation. Focusing on long-term views and avoiding tactical decisions allows us to deliver a straightforward, intuitive approach to risk management while keeping costs low. Using a broad stable of asset classes promotes efficient portfolios in concert with participant objectives at each stage of their careers. The ultimate goal is to provide meaningful levels of real income replacement in retirement -- whether that is delivered through traditional measures or by converting to a lifetime income stream.
Figure 2: Asset Class Diversification — Index Managers
State Street’s broadly diversified approach allows us to break out exposure within equities, bonds and inflation sensitive asset classes in order to express a view on the most appropriate mix of characteristics at each stage of participants careers. For example, we hold a longer duration fixed income allocation for younger investors due to the diversification benefits that longer duration bonds offer in equity-heavy portfolios, and strategically reduce that duration over time as participants hold more fixed income and interest rate risk becomes of greater concern. Similarly, rather than using one fund to provide broad (but static and inflexible) exposure to US equity markets, State Street builds in a structural overweight to Small and Mid-Cap stocks for younger investors. Stocks of these companies offer investors greater long-term growth expectations in exchange for higher volatility — a tradeoff that can be more appropriate for investors with long time horizons. As participants age and priorities change, this structural overweight is strategically reduced.
State Street’s scale and experience as an index manager is the key to delivering this broadly diversified solution at low cost. As testament to the value of our approach, State Street’s Target Retirement strategies have grown from $66 billion in 2018 to $163 billion as of March 31, 2023.
There is unlikely to be a “one size fits all” income solution that will fit all plan demographics and participant needs. However, one fact will always apply – a higher accumulated balance at retirement will lead to more meaningful retirement income.
State Street’s glidepath is designed to balance wealth accumulation goals with volatility and inflation risks as participants approach retirement. The strategy uses five underlying funds to evolve our fixed income asset allocation intelligently as participants get older. As retirement age approaches, we add more diversified fixed income exposure, pairing US aggregate bonds with short duration exposure to reduce volatility and protect against the impact of rising interest rates. By breaking out our fixed income exposure, State Street’s diversified approach provides more control, and greater emphasis on interest rate risk than what is typically found in passive solutions.
Additionally, a key limitation of most guaranteed income vehicles is that inflation adjustments are prohibitively expensive in terms of the impact on income. As a result, inflation is a key risk for participants regardless of whether they elect lifetime income. State Street incorporates three inflation-sensitive asset classes, Commodities, REITs and TIPS, in order to provide a portfolio designed to be more resilient in periods of rising inflation.
What does this look like in practice? Analyzing fund vintages that are closest to retirement today where guaranteed income may come into play, State Street’s fund vintages have delivered strong peer relative returns over long time horizons. Below, we highlight the fund vintages closer to retirement over the last fifteen years. In the two vintages most likely to be held by today’s retirees, State Street’s Target Retirement Collective Investment Trust series has outperformed 96% of peers. These key wealth accumulation years have the greatest impact on retirement, as participants typically have their largest balance in these years and the impact of investment returns, and risk management, is highlighted.
|Period Ending March 31, 2023
Morningstar US Peer Universe Percentile Rank(%)
|15 Year Ranking|
|State Street 2035 (Net 12 bps)||19|
|State Street 2030 (Net 12 bps)||12|
|State Street 2025 (Net 12 bps)||3|
|State Street 2020 (Net 12 bps)||4|
|Average Rank (%)*||10|
A consistent concern expressed by investment decision makers in the adoption of retirement income solutions has been liquidity and portability, both at the plan and participant level. Approaches that incorporate annuities directly into the glidepath have the potential to limit growth, add costs, and impact flexibility for plan sponsors who wish to make a change to the plan default.
Further, if not implemented properly these features may disadvantage participants who do not ultimately benefit from the lifetime income feature. For example a participant who switches jobs (the average participant is expected to hold 12 jobs throughout their career) may have paid higher fees throughout their tenure for a feature that they likely will not benefit from. Additionally, solutions that add investment management expenses while offering participants the option to add lifetime income may be harming those who do not make that election.
By using index-based building blocks throughout the glidepath, State Street is able to leverage scale in order to manage costs while not introducing illiquid components or increasing investment management fees at any point in the glidepath. This ensures that participants do not compromise what is working today – namely the low-cost, liquid and efficient approach to wealth accumulation that Target Date Funds offer – while adding a lifetime income plan for those who want it.
Choosing a Target Date manager is about selecting the right long-term partner to work with your plan towards delivering retirement readiness. While the newer features of retirement income are justifiably a key area of focus, it is important not to forget about the foundational attributes that can drive successful retirement outcomes. For plan sponsors considering incorporating retirement income into their plan default, these attributes should be considered in tandem rather than in isolation.
We believe now is the right time to engage in conversations around retirement income solutions, drawing on progress made by the asset management, recordkeeper and plan sponsor communities in addressing the many hurdles that come with innovative change. State Street offers unique insights in this regard – having deep experience working with the many stakeholders necessary to successfully implement a solution.
1 Source: Vanguard, How America Saves 2021 report.
2 Source: BLS.Gov
For institutional / professional investors use only.
United States: State Street Global Advisors, 1 Iron Street, Boston, MA 02210
T: +1 617 786 3000
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.
All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
The views expressed are the views of the Defined Contribution team through June 21, 2023, and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Investing involves risk including the risk of loss of principal.
SSGA Target Date Funds are designed for investors expecting to retire around the year indicated in each fund’s name. When choosing a Fund, investors should consider whether they anticipate retiring significantly earlier or later than age 65 even if such investors retire on or near a fund’s approximate target date. There may be other considerations relevant to fund selection and investors should select the fund that best meets their individual circumstances and investment goals. The funds' asset allocation strategy becomes increasingly conservative as it approaches the target date and beyond. The investment risks of each Fund change over time as its asset allocation changes.
Payment of the lifetime income is subject to the claims-paying ability of the issuing insurance company; it is possible that the issuing company may not be able to honor the income payouts at any time. Neither IncomeWise nor the [Annuity/ QLAC] are insured by the FDIC or by another governmental agency; they are not obligations of the FDIC or deposits or obligations guaranteed by SSGA. The [Annuity/QLAC] is not provided by or guaranteed by SSGA or any affiliate of SSGA. [Annuity/QLAC] purchases are subject to regulatory limitations.
The guaranteed lifetime income benefit is a type of deferred income annuity, called a qualified longevity annuity contract (QLAC), which is an insurance product that guarantees money at a future date, typically for the rest of an individual’s life. Participants who redeem from the fund prior to the QLAC purchase will not be eligible for the QLAC benefits. The QLAC is subject to regulatory limitations. The QLAC purchase is subject to market availability and cannot be guaranteed in any given year. The QLAC is not provided by or guaranteed by SSGA or any affiliate of SSGA. Neither IncomeWise nor the QLAC are insured by the FDIC or by another governmental agency; they are not obligations of the FDIC or deposits or obligations guaranteed by SSGA. You cannot reverse the purchase of the QLAC.
Diversification does not ensure a profit or guarantee against loss.
The trademarks and service marks referenced herein are the property of their respective owners. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.
Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations.
Investing in high yield fixed income securities, otherwise known as “junk bonds”, is considered speculative and involves greater risk of loss of principal and interest than investing in investment grade fixed income securities. These Lower‐quality debt securities involve greater risk of default or price changes due to potential changes in the credit quality of the issuer.
Equity securities may fluctuate in value and can decline significantly in response to the activities of individual companies and general market and economic conditions.
Investing in commodities entail significant risk and is not appropriate for all investors. Commodities investing entail significant risk as commodity prices can be extremely volatile due to wide range of factors. A few such factors include overall market movements, real or perceived inflationary trends, commodity index volatility, international, economic and political changes, change in interest and currency exchange rates.
Investing in REITs involves certain distinct risks in addition to those risks associated with investing in the real estate industry in general. Equity REITs may be affected by changes in the value of the underlying property owned by the REITs, while mortgage REITs may be affected by the quality of credit extended. REITs are subject to heavy cash flow dependency, default by borrowers and self-liquidation. REITs, especially mortgage REITs, are also subject to interest rate risk (i.e., as interest rates rise, the value of the REIT may decline).
Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.
Investments in mid-sized companies may involve greater risks than in those of larger, better known companies, but may be less volatile than investments in smaller companies.
Investments in small-sized companies may involve greater risks than in those of larger, better known companies.
Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
Not FDIC Insured
No Bank Guarantee
May Lose Value
© 2023 State Street Corporation.
All rights reserved.
Exp. Date: 6/30/2024