Guaranteed Lifetime Income Solutions

by Bernard Winograd

Prudential Financial

Executive Vice President

Chief Operating Officer, U.S. Businesses

Americans face two key challenges in planning for their retirement. In the savings accumulation phase, most notably during their working years, individuals need to save a sufficient amount to provide for a more secure retirement. In the retirement income, or payout, phase, they need to generate an adequate, guaranteed source of lifetime income.

The Pension Protection Act of 2006 (PPA) strengthened the savings aspect of retirement planning by supporting the use of “autopilot” DC plan features. However, more needs to be done to help individuals with the payout period. Congress should consider how federal legislation could extend the autopilot concept to the retirement income phase, as discussed below.

At Work

In the past, many Americans who had a workplace plan were able to rely on traditional pension plans to provide a monthly “paycheck” for life. These plans are fast disappearing. Among the roughly 50% of workers with retirement plan coverage, the percentage covered by traditional defined benefit (DB) plans has fallen from 81% in 1981 to 36% in 2004.[i] These plans are being replaced, for the most part, by defined contribution (DC) plans that leave it to workers to put aside part of their paycheck—making them personally accountable for making investment decisions and managing their own nest eggs.

The PPA was intended to maintain the financial strength of DB retirement plans and to increase participation and savings rates in DC plans. With respect to DC plans, the PPA provided support for the usage of autopilot features. Autopilot DC plan features include automatic enrollment, contribution escalation, investment defaults, and asset rebalancing. In addition, the PPA authorized plan sponsors to offer professional investment advice. As a provider of DC plans, Prudential Retirement includes autopilot and advice features in its suite of DC plan offerings.

Early indications are that the PPA has been successful in facilitating the transformation of DC plans into more robust retirement savings vehicles. The percentage of employers that automatically enroll participants increased from 19% in 2005 to 34% in 2007. This is especially significant—when new hires are automatically enrolled in a 401(k) plan, participation reaches about 90% on average, compared to an average participation rate of 78% for eligible employees in all companies’ 401(k) plans.[ii]

However, about 75 million employees are not covered by a retirement plan through their place of work. One proposal, which would cover about half of these workers, would require employers of 10 or more employees who do not offer their workers an employment-based retirement plan to offer an Individual Retirement Account through payroll deduction. This “Automatic IRA” would include many of the same autopilot provisions that are being added to DC plans. The intent of the proposal is to encourage employee savings while not imposing significant cost or administrative burdens on employers, such as matching worker contributions or discrimination testing. A recent Prudential Financial study found that, among workers not covered by workplace retirement plans, more than half of those surveyed would use the plan to add to their retirement savings, rather than replace other types of savings, thereby providing them a potentially more secure retirement.

At Retirement

The first wave of Baby Boomers has reached retirement age, and many more will do so in the coming years. By 2030, 20% of the U.S. population will be 65 or older – over 71 million people.[iii] In addition, people on average are living longer, due to advances in medical treatment and technology, and retirees will have to pay more for healthcare at the same time that they will need to have their retirement savings last longer.

Increasingly, individuals will need to view their DC plan as more than just a savings vehicle—they must also view it as a retirement planning tool from which to generate income to support their retirement. A new challenge facing individuals at retirement is how to invest the lump sum they have accumulated in a way that will provide an assured amount of income for the remainder of their lives. They have a wide choice of investments – stocks, bonds, mutual funds, and more. All involve a degree of risk. Research shows employees and retirees are confused and uncertain how to invest their retirement nest eggs. While most pre-retirees know they need to generate a paycheck in retirement, only a small percentage believe they are well-informed about how to do that; similarly, only a small percentage have a high degree of confidence as to the sufficiency of their retirement income.[iv]

Source: Prudential Financial's Fourth Annual Workplace Report on Retirement Planning, 2005

How Congress Can Help

Congress should build on the success of the PPA by enacting measures that encourage Americans to create guaranteed streams of lifetime income. Within DC plans, Congress should encourage the use of investment options that incorporate guaranteed retirement income features by providing a clear safe harbor for plan sponsors who offer such an investment or choose to designate it as the plan’s Qualified Default Investment Alternative. Plan sponsors understand the need to help employees achieve more DB-like outcomes from a DC plan, and many have expressed the need for more explicit protection in order to take the steps necessary to achieve this result.

A safe harbor should also be available for plan sponsors who make guaranteed lifetime income the default distribution option for at least a portion of employees’ DC account balances. Extending the autopilot concept into the payout phase in this way would:

  • Help provide protection against the risk of outliving one’s assets and the risk that the investments do not perform as well as anticipated.
  • Relieve retirees of the confusion and uncertainty they face in managing their retirement funds.
  • Provide an often-needed personal supplement to Social Security.

These actions would help create more certain outcomes in today's DC world, and address the high priority concerns both employers and employees have with respect to retirement security.

A Promising Solution

Prudential Retirement has been a leader in introducing a new generation of retirement income solutions – solutions that provide guaranteed income without the rigidity of traditional annuitization. First introduced in the retail marketplace, the concept has now been adapted for use within DC plans. Prudential’s innovative guaranteed lifetime income solutions invest retiree funds in a well-diversified group of income producing assets. They also provide retirees the flexibility to stop payments at any time, or to use the funds for unforeseen expenses.

The essential elements of Prudential’s guaranteed lifetime income solutions are:

 A guaranteed minimum amount of income every year of life, even if market losses completely deplete the account.

Guaranteed increases, during the accumulation years, in the amount that will be used to calculate income.

Potential growth from market gains.

 Protection of retirement income from market downturns. (In fact, individuals may choose to remain invested in the market longer, and/or more aggressively, than otherwise, due to the protection afforded by the guarantees.)

Access to principal—with no loss of control.

  • Wealth transfer—any amount remaining in the account after the retiree dies may be passed to heirs.

Because of their flexibility, particularly the ability for retirees to stop the income stream at any time, these new generation retirement income products would be ideal candidates for consideration as default distribution options.

Guarantees are based on the claims-paying ability of the insurance company and are subject to certain limitations, terms and conditions. To maintain the IncomeFlex benefit, you must invest in one or more Prudential IncomeFlex Funds. Like all variable investments, these funds may lose value. Guaranteed growth of the income base ends at age 70 or when guaranteed withdrawals begin, whichever is earlier. Withdrawals in excess of the guaranteed lifetime income amount will reduce future guaranteed withdrawals proportionately.

Prudential IncomeFlex Funds are separate accounts available under group variable annuity contracts issued by Prudential Retirement Insurance and Annuity Company (PRIAC). PRIAC does not provide any guarantee of the investment performance or return of contributions to those separate accounts. PRIAC’s guarantee of certain withdrawals is supported by PRIAC’s general account and is contingent on its claims paying ability. Guarantees are subject to certain limitations, terms and conditions. Investors should consider the objectives, risks, charges and expenses of the funds and guarantee features before investing. Contract form# GA-2020-IFGW2-0805 or state variation thereof.
You should carefully review the Prudential IncomeFlex Important Considerations before investing.
Product availability and terms may vary by jurisdiction. Subject to regulatory approvals.
Prudential Retirement and Prudential Financial are registered service marks of The Prudential Insurance Company of America, Newark, NJ and its affiliates. Prudential Retirement is a Prudential Financial business.

1

[i] Center for Retirement Research at Boston College calculations from U.S. Department of Labor Form 5500 data, May 2008.

[ii] Hewitt Associates, “Trends & Experience in 401(k) Plans,” 2007, and “Automatic Enrollment Boosts Participation and Retirement Savings,” 2007.

[iii] U.S. Census Bureau, “Statistical Abstract of the United States,” Table 12, 2008.

[iv] Prudential Financial’s Fourth Annual Workplace Report on Retirement Planning, 2005, page 3.