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Longevity risk – or outliving one’s savings – has become a critical threat facing retirees and one that will only rise as life expectancy increases and people spend decades, not years, in retirement.
This summary explains how our retirement income approach balances liquidity flexibility with income security in an effort to benefit both plan sponsors and the participants they serve.
For the full whitepaper, co-authored by the Regents of University of California, contact us.
Retirement Investors and Longevity Risk
DC plans are rapidly becoming the primary source of retirement savings for many Americans. While this shift means investors have more flexibility, portability and control over their savings, it also requires more responsibility for making the right investment decisions. As medical breakthroughs and healthier living extend lifespans, regular investors have to determine how to ensure their retirement assets create a steady post-retirement income that lasts a lifetime.
Target date funds provide a dynamic mixture of growth, income and downside protection assets that shift over time as a participant nears retirement, providing a simple yet comprehensive investing path during the working years. Features such as automatic enrollment and savings escalation have also shifted investors’ default behaviors in ways that have improved participation rates and encouraged healthier levels of savings.
These enhancements have addressed many of the investment challenges facing DC participants, including increased savings, asset allocation and rebalancing. However, we believe that DC plans and the investments employers are providing still fall short as employees transition into their retirement years.
Most importantly, longevity risk, which Defined Benefit (DB) plans cover through a guaranteed lifetime income, remains unaddressed in the standard DC plan structure. This shortcoming leaves DC participants exposed to the catastrophic risk of outliving their assets.
Balancing Income Security with Flexible Liquidity
Our research shows that many participants would benefit from using part of their balance at retirement to purchase an annuity. Not having to protect against the risk of outliving their assets may allow participants to make higher annual withdrawals from the rest of their balance (Figure 2) and may provide them with a more stable income for the rest of their lives.
The new solution that State Street has developed evolves a target date fund to include the option to purchase longevity insurance in the form of a deferred annuity.
The solution operates as a traditional target date fund until the participant reaches the target retirement age (age 65), at which point they are given the option to purchase the deferred income annuity (known as a Qualified Longevity Annuity Contract or QLAC). If selected, a portion of the participant’s balance will be used to purchase the annuity, from which future payments are scheduled to start at age 80. Because the annuity purchase is part of the solution, and incorporates pre-selected features, it provides a level of simplicity —requiring minimal additional effort from participants wishing to provide themselves with lifetime income in retirement. The remaining assets will remain in liquid form for the participant to use as they wish. Figure 3 below shows how the solution works.
*Assumed age at retirement; The information contained above is for illustrative purposes only. Participants who redeem prior to the annuity purchase will not be eligible for annuity income benefits. QLAC purchase is subject to market availability.
By using only part of the balance to purchase a deferred annuity, this solution combines the lifetime income traditionally associated with a DB plan with the flexibility of a DC plan. In addition, participants can use the guaranteed nature of the annuity to more effectively budget the remainder of their assets . The annuity helps address the risk of “living too long”, thereby potentially shortening the time horizon in which participants need to make their assets last. Because of the guarantee of the annuity, participants have greater flexibility to spend early in their retirement.
State Street and The Regents of the University of California are committed to achieving strong retirement outcomes for participants through innovations in retirement solutions and plan design. We also share the goal of resolving remaining implementation issues through the introduction of new approaches and the engagement of stakeholders across the value chain and encourage other like-minded industry leaders to join us in helping to implement the next wave of DC innovation to shape the future of retirement.
Annuity: An annuity is a financial product that funds a series of fixed payments to an individual, primarily used as an income stream for retirees. Annuities are created and sold by insurance companies, which accept and invest funds from individuals. Upon annuitization, or the commencement of the payment series, funds are paid at regular intervals over time. In the case of annuities structured for retirees, payment typically spans an individual’s life.
The annuity contract’s financial guarantees are solely the responsibility of and are subject to the claims-paying ability of the issuing insurance company. Annuities are issued by third-party insurance companies, which are not affiliated with any State Street Bank and Trust Company entity, including State Street Global Advisors.
*All calculations made using mortality rates from the Society of Actuaries RP-2014 mortality tables for healthy annuitants using a 50/50 blend of male and female mortality and ISG capital market forecasts for Q2/2018. The median life-expectancy at age 65 in these tables is 86. Drawdown assumptions include a 2% cost of living adjustment (COLA) and a retirement age of 65.
Self-managed drawdown: we assume the participant has all their retirement assets in a 35/65 portfolio with an expected return of 4.5% and a risk level of 5.5%. The drawdown rate is the annual rate at which a participant could draw down their assets with a 95% probability of not exhausting their assets during their lifetime.
Hybrid: we assume the participant uses 25% of their retirement assets to purchase a 50% joint and survivor annuity with a return of premium benefit and a 2% COLA which starts payments at age 80 and invests the remainder of the assets in a 35/65 portfolio with an expected return of 4.5% and a risk level of 5.5%. The hybrid drawdown rate is the continuous annual rate at which the participant could draw down their assets between the ages 65 and 80 and use the remainder of their assets to supplement their annuity income after the age of 80. The drawdown rate is the annual rate at which a participant could draw down their assets with a 90% probability of not exhausting their assets during their lifetime. A higher shortfall risk is assumed for the hybrid solution because of the backstop of annuity payments at age 80.
Annuity: The drawdown rate is the annual payment that the participant would receive if they used all their retirement assets to purchase an immediate 50% joint and survivor annuity with a 2% COLA starting payments at age 65. Calculations for the self-managed drawdown and the drawdown portion of the hybrid solution are based on simulations (simulation count = 100,000) and do not reflect the effects of unforeseen economic and market factors on decision-making. Annuity prices are based on indicative institutional quotes for April 2018. Expected returns are based upon estimates and reflect subjective judgments and assumptions.
The views expressed in this material are the views of SSGA Defined Contribution as at March 20, 2020, 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.
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. Investing involves risk, including the risk of loss of principal. 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.
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.
Diversification does not ensure a profit or guarantee against loss.
Ages and expected dates of retirement are approximate and may not accurately reflect the age or retirement date of each participant at each stage of the product. Participants are responsible for selecting their own target retirement date.
An annuity contract’s financial guarantees are solely the responsibility of and are subject to the claims-paying ability of the issuing insurance company.
Average US life expectancy at age 80 is 9.48 years (UN population projections). The annuity described in this paper incorporates a return of premium and cash refund benefit. This means that if the participant (and spouse in the case of a J&S annuitant) dies before they have recouped their initial premium, the difference between the initial premium and the payments received will be returned to the estate.
Annuities are issued by third-party insurance companies, which are not affiliated with any State Street Bank and Trust Company entity, including SSGA.
This information is for informational purposes only, not to be construed as investment advice or a recommendation or offer to buy or sell any security. Investors should always obtain and read an up-to-date investment services description or prospectus before deciding whether to appoint an investment manager or to invest in a fund. Any views expressed herein are those of the author(s), are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients. There are no guarantees regarding the achievement of investment objectives, target returns, portfolio construction, allocations or measurements such as alpha, tracking error, stock weightings and other information ratios. The views and strategies described may not be suitable for all investors. SSGA does not provide tax or legal advice. Prospective investors should consult with a tax or legal advisor before making any investment decision. Investing entails risks and there can be no assurance that SSGA will achieve profits or avoid incurring losses.
Performance quoted represents past performance, which is no guarantee of future results. Investment return and principal value will fluctuate, so you may have a gain or loss when shares are sold. Current performance may be higher or lower than that quoted.
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