Executive Summary
- Participating in Defined Contribution ("DC") plans such as 401(k), 457, and 403(b) plans is the primary way most people save for retirement, so it is important for DC plans to be designed with a focus on participant outcomes. A well-designed plan can provide participants with an effective means of not only accumulating assets but also generating income in retirement.
- Incorporating lifetime income options into a DC plan can help fiduciaries improve participant outcomes. Fiduciaries have access to more lifetime income options than ever before, and they have the ability to design lifetime income programs that both achieve the desired outcomes for participants and mitigate fiduciary risk.
- Being a fiduciary is about more than just avoiding lawsuits—it is about improving participant outcomes. Lifetime income options can help participants convert their savings into retirement income, and a fiduciary's selection of a lifetime income option is not fundamentally different from the selection of any other DC plan investment. The primary difference is that many lifetime income options come with guarantees from insurers that need to be evaluated.
- Fiduciaries have a number of tools at their disposal to mitigate risk, including delegating responsibility to investment managers or trustees and relying on the growing body of regulatory guidance. Many lifetime income options incorporate these tools into the product design, and fiduciaries should understand how design choices impact overall legal risk.
- Lifetime income options come in a variety of flavors, and fiduciaries can determine which approach will result in the best outcomes for participants. Some lifetime income options simply provide guidance to participants in drawing down their balances while other options provide guarantees backed by state-licensed life insurance companies. Different options require different levels of participant engagement with some requiring participants to make decisions for themselves and others using a more "do it for me" approach.
- Providers have taken a number of different approaches to designing guaranteed lifetime income options, and now, there are options that can accommodate fiduciaries' preferences and risk tolerances while also achieving optimal participant outcomes.
- See page 13 for a chart summarizing some of the key issues for plan fiduciaries considering the incorporation of lifetime income options into their DC plans.
Focus on Retirement Income
Participating in DC plans such as 401(k), 457, and 403(b) plans is the primary way most people save for retirement, and there is considerable sponsor and participant interest in making DC plans more effective at their primary goal: providing income in retirement. In the past, this could seem like a daunting challenge, but today, there are more options than ever before, and fiduciaries have the ability to design a lifetime income program that both achieves the desired outcomes for participants and mitigates fiduciary risk.
Over the course of a single generation, DC plans have evolved from being supplemental savings programs to becoming the primary – and typically the only – retirement plan for most employees. As employees and retirees have come to rely more and more on DC plans, sponsors and policymakers have made great strides to improve the DC system by increasing participation (e.g., auto-enrollment), expanding access, improving transparency (e.g., fee disclosure), and professionalizing management and administration. Now, there is a growing focus on providing opportunities to participants to not only save for retirement but to convert their savings into a reliable source of income in retirement.
It is understandably difficult for participants to make their DC plan savings last a lifetime, and even investors with substantial assets may not understand how to transform their portfolios into retirement income. Consequently, many participants are acutely aware that they are at a real risk of outliving their savings. Approximately half of participants are concerned about running out of money in retirement, and "85% of plan participants wish their employer's retirement plan had an option designed to help generate a stream of income in retirement." 1
More than 80% of sponsors feel a strong sense of responsibility to help participants generate income in retirement, so it is not surprising that plan sponsors are increasingly considering products and features to help participants convert their savings into a reliable source of retirement income.2 This can have important benefits for participants, including simplifying the overall retirement experience, reducing risk, and improving trading behaviors.3 Adding lifetime income features to a plan may also help employers manage their workforces. For example, research indicates that "[i]ncreased participant satisfaction can help promote employee loyalty."4
For fiduciaries looking at lifetime income options, it is important to understand that the products and services available in the market today have evolved significantly from those available in the past. There are now options available to achieve almost every goal and accommodate most fiduciaries' risk tolerances. This paper provides background to help fiduciaries better understand their legal obligations when considering lifetime income options and the products and services available.
Fiduciary Basics
Being a fiduciary is about more than just avoiding lawsuits. It is about improving participant outcomes. Lifetime income options can help participants convert their savings into retirement income, and a fiduciary's selection of a lifetime income option is not fundamentally different from the selection of any other DC plan investment. The primary difference is that many lifetime income options come with guarantees from insurers that need to be evaluated.
Under ERISA, a person generally becomes a fiduciary if he or she exercises discretion over the management or administration of a plan, including selecting plan investments.5 Fiduciaries are required to –
- Carry out their duties "with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims;"
- Discharge their duties with respect to a plan "solely in the interest of the participants and beneficiaries;" and
- Act for "the exclusive purpose of providing benefits and defraying reasonable expenses of administration."6
To satisfy these duties, fiduciaries need to engage in a prudent process.7 Although there is no onesize-fits-all process for fiduciaries, it is important, as applicable to the specific situation, to gather relevant information, consider available courses of actions, consult experts when necessary or helpful, and make reasoned decisions based on all relevant facts and circumstances that they know or should know.8 It is equally important to document this process to create evidence of ERISA compliance in the event decisions are questioned.
Notably, ERISA provides fiduciaries considerable discretion in designing investment programs for their DC plans. For example, no particular investment is required or per se imprudent under ERISA.9 Therefore, while a fiduciary is not required to select the lowest cost investment, the fiduciary must ensure that the benefits provided justify the costs.
A fiduciary's selection of a lifetime income option is not fundamentally different from the selection of any other DC plan investment. The primary difference is that many lifetime income options come with guarantees from insurers that need to be evaluated. This means that a fiduciary must understand the costs of the annuity or annuities and how the underlying insurance contracts work, including any rights of policyholders. In addition, fiduciaries may also evaluate the insurer's financial wherewithal to make good on its payment obligations, which may span decades.
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Footnotes
1. Greenwald Research, Plan Participants Want Options That Generate Retirement Income in Their Workplace Retirement Plans (Jan. 12, 2022) (link).
2. J.P. Morgan Asset Management, Continued Progress Through Partnership: Expanding the Trend of Doing More for Participants (2023) (link). See also Nationwide Retirement Institute, 2021 In-Plan Lifetime Income Survey (Sept. 10, 2021) (3. PGIM, Stay the Course (Feb. 2022) (link).
4. EY, Protected Retirement Income Solutions: What Plan Sponsors Need to Know About a New Generation of Offerings (Feb. 22, 2024) (link).
5. The rules applicable to fiduciaries are discussed in more detail in our Practical Guide for Selecting DC Plan Lifetime Income Options and our analysis of the Lifetime Income Provisions Under the SECURE Act.
6. ERISA § 404(a).
7. See, e.g., Donovan v. Mazzola, 716 F.2d 1226, 1232 (9th Cir. 1983), cert. denied, 464 U.S. 1040 (1984) (prudence involves an examination of whether the trustees "employed the appropriate methods to investigate the merits of the investment and to structure the investment"); Donovan v. Walton, 609 F.Supp, 1221, 1238 (S.D. Fla. 1985), aff'd sub nom., Brock v. Walton, 794 F.2d 586 (11th Cir. 1986); Eyler v. Comm'r of Internal Revenue, 88 F.3d 445, 454 (7th Cir. 1996); DiFelice v. U.S. Airways, Inc., 497 F.3d 410, 420 (4th Cir. 2007).
8. In re Unisys Sav. Plan Litig., 74 F.3d 420, 434–35 (3d Cir. 1996).
9. 44 Fed. Reg. 37221, 37225 (June 26, 1979).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.