I was on a long cross-country flight with our Director of Benefits, coming back from a meeting with our lawyers in ongoing litigation (yes, over fees) in California. I lost the coin flip – Charlie got the aisle seat and I was sitting in the middle. And sitting next to me, by the window, was a short, older bald guy with a gray mustache. Somewhere over the Imperial Valley, he introduced himself.
“I’m Rob Steadman.”
“Oh hi, I’m Al Kidway and this Charlie Bogart.”
Rob and I got to talking and it turned out that he was also in the retirement plan business – he was the investment guy for his company’s plans. We spent about half an hour talking about different asset allocation strategies and the Fed. Then, at some point, Charlie leaned over and asked, “What are you doing about retirement income?”
Rob said, “What do you mean?”
Charlie said, “One of the toughest challenges we face is helping employees figure out what to do with their money when they retire.”
Rob gave Charlie a sort of quizzical look and said, “Can you tell me more? What’s your experience with this problem?”
“Well,” said Charlie, “we do a good job of getting people enrolled in the plan and providing our participants with investment options, and they do ok with those investments ….”
“Except when they’re suing us,” I interjected.
“… but – my brother retired from the company last year and he came to me and asked me what to do with his money and I have to admit I hadn’t a clue what to tell him. He had a very nice nest egg – close to half a million dollars – but it turns out when you retire, all of a sudden you start caring about income more than how big your pile is.”
“Yeah,” said Rob, “that’s a funny thing – my sister asked me the same thing last year. She was thinking about retiring and she explained to me that her biggest concern was, she wasn’t going to have any more money coming in from work, so she needed to make sure that the money coming in after she retired was going to at least cover her expenses.”
“The old income vs. expenses deal,” said Charlie.
“Yeah. It turns out that while your 401(k) account looks very cool while it’s building up – and you’re earning a salary – when you take a look at not earning any more money, because you’re retiring, all you care about is how much income you have, and all you worry about is running out. Plan B looks pretty scary.”
Charlie asked, “So what did you tell her?”
“Well, her company is like yours, I’m guessing. Their retirement program is a 401(k) plan. We talked about annuities …” he made a face.
“They are so darned expensive though.” I observed, grimly.
“Yeah,” said Charlie, “the last time my brother checked, his $500,000 only bought an annuity of $37,000 a year.”
“Still, that might be the smartest thing to do,” said Rob. “If you do one of these draw down strategies they talk about – what’s the recommendation? 3-4% a year? – you’d only get half that.”
“The thing is, with a 401(k) plan, you have to buy the annuity from an insurance company. They’re super-complicated and hard to understand. People are really reluctant to do all that. So, they wind up rolling the dice and worrying. And hoping that the stock market doesn’t crater.”
“Yeah,” I said. “Even if stocks deliver long-run returns, the impact of just one bear market on a fixed pot of retirement assets is hard to come back from.”
Rob nodded in agreement. Then he asked, “Do you buy this idea of putting annuities in your plan, as an investment option, or maybe even a default option? At least then you might be able to get an institutionally priced deal for them.”
“We wouldn’t touch that with a barge pole.” Charlie said. And I chimed in: “No way. We’ve got enough litigation just over our regular stock fund investment options.”
“So, at your company,” Rob said, “the employee just gets her lump sum and fends for herself.”
Charlie and I nodded.
After a long silence, Rob spoke up. “Here’s an idea I’ve been thinking about ever since that conversation with my sister.”
Charlie leaned over, unable to restrain his curiosity – “What?”
“This isn’t, like, a silver bullet. But it helps,” Rob said. “At our company, we have this defined benefit plan. It’s been frozen for over a decade. But – unlike a 401(k) plan, where you have to buy an annuity from an outside insurance company – a defined benefit plan can pay an annuity right from the plan.”
“And …?”
“Let’s assume your brother worked at our company – we could just move his $500,000 over to our DB plan, convert it to an annuity and just pay him from the plan. The IRS came out with a roadmap explaining how to do all that – how to take a lump sum from a 401(k) plan and move it into your DB plan to pay an annuity – way back in 2012.
“Because we’re cutting out the middleman and not trying to make a profit, our DB plan benefit would be bigger than what your brother could get from an insurance company – about $40,000 – that’s like an extra month’s retirement pay.”
“Not that much though.”
“Not so fast. This is a pretty good deal. First of all, every little bit helps. Second, for my sister, the deal is even better. For $500,000 she would only get $34,000 a year from an insurance company – because as a woman they think she’ll live longer. But our DB plan can’t take sex into account – her $500,000 would buy the same annuity your brother could – $40,000 a year.
“Third of all – it’s coming from the company, from the company’s plan. And it shows that we’re doing something to help them with this problem – not just turning them over to some stranger insurance company.”
But I said, “OK I hear you and it does sound like a pretty cool idea. But my CFO hates DB plans. That’s why we froze ours. Like so many other companies.”
Rob had an answer that too. He said, “Have you asked him lately? One thing frozen pension sponsors have found out is that managing ‘mature’ pension obligations, like retirees, is vastly easier than underwriting defined benefit accruals for benefits that won’t be paid for 40 or 50 years. Retiree payments are made over a reasonably short horizon and most of the mortality risk can be ‘pooled’ away so long as the pool includes a couple hundred lives. Straightforward investment strategies for managing this risk on the employer balance sheet are commonplace now, as are group annuity solutions from insurers at prices in line with company balance sheets.”
“This isn’t like the 1990s, when companies were long the market and short their liabilities and got hammered by interest rates.”
There was another long pause.
Then Charlie said, “So all you need is one of these frozen DB plans. … Hey Al, don’t we have one of those?”
Michael P. Barry is a senior consultant at October Three and President of O3 Plan Advisory Services LLC, which provides retirement plan regulatory analysis targeted at plan sponsors and those who provide services to them.
Opinions expressed are those of the author, and do not necessarily reflect the views of ASPPA or its members.
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