Self-Directed IRAs: Challenges and Options
April 13, 2018
Jenna Dagenhart: Hello, and welcome to Asset TV's Retirement Income Master Class. We'll cover what you need to know about the Secure Act, creative ways to find income in this low-yield environment, how the Coronavirus pandemic is changing the way people approach retirement, and much more.
Jenna Dagenhart: Joining us now are three expert panelists, Ruthann Pritchard, institutional portfolio manager at Fidelity Investments, Chris Previti, managing director of distribution for individual solutions at Trans America Capital, and Steve Gilbert, director of advanced planning at Prudential Annuities.
Jenna Dagenhart: Everyone, thank you for joining us.
Chris Previti: Thanks for having us.
Jenna Dagenhart: And I know that the coronavirus pandemic is top of mind for a lot of investors. Ruthann, do you think COVID-19 is changing the way they think about retirement?
Ruthann Pritchard: I think Fidelity is very fortunate to be able to answer this from two perspectives. One, from the personal investing side of the house, so to speak, and the other from the workplace investing vantage point. So overall, what we've seen for retirees is that, quite frankly, they are more concerned about being isolated from their children and their grandchildren, and not as concerned about their finances.
Speaker 5: Oh, thank you.
Ruthann Pritchard: About 10% are worried about paying their bills, and that makes sense, right? They're not concerned about job loss, and they may have a broader perspective about market volatility. They've lived through the oil crisis, the energy crisis, 9/11, 2008, and they probably were prepared for a pullback and might have even expected it.
Ruthann Pritchard: And then, when you look at those that are close to retirement, what we call pre-retirees, about a third of them are worried about their finances, and the future of the economy and the workforce are so unknown, and I think it's really incumbent upon plan sponsors and us in the financial industry to be sure that we give everyone the support, the tools, and the products and solutions that they need to be able to confidently retire whenever that happens.
Ruthann Pritchard: And then, for the youngest ones, they're concerned about job loss. About half are worried about their finances and being able to pay the bills, and the recovery is going to be key to see how they view retirement and saving for retirement going forward.
Ruthann Pritchard: So that's the personal side, and then on the workplace side, we're really pleased to see that define contribution participants largely stayed the course during the volatility, and that's so important because whether you're 25 years old or you're 65, you still have to fund 25 to 30 years of spending in retirement through your retirement savings.
Ruthann Pritchard: So staying invested in the market and having an asset allocation that's appropriate for your age is really key. So, there's a line graph that I'd like to share with you right now. We have 22 million participants, or about one in four of every defined contribution participant in the country on our record-keeping platform.
Ruthann Pritchard: So we're able to go in and look at participant behavior and this graph highlights the percentage of participants over time making an exchange in any given quarter since 2000. So, making an exchange is not withdrawing from the plan, it's picking up your assets and moving them from one fund in the plan to another.
Ruthann Pritchard: The dark blue line represents participants who are responsible for their own asset allocation, meaning they're not in a target date strategy or a managed account, and you can see on the right-hand side that nearly 10% of those participants made an exchange and 12% of those actually went to 0% equity. So that's a pretty significant uptick from what we've seen in the past, but it's still only 10%, so only one in 10 participants reacted.
Ruthann Pritchard: But the green line is really interesting. That's those participants that are 100% invested in target date funds. So, these investors didn't move their assets. They stayed the course with only 0.3% of participants making an exchange.
Ruthann Pritchard: So overall, on both the personal investing side and the workplace investing side, we think the participants are making thoughtful responses to shorter term market events.
Jenna Dagenhart: And Steve, Ruthann brings up a good point about staying invested. What would you say is the difference between saving versus investing? Having money under the mattress versus putting it to work and watching it grow. And then, how would you say the pandemic is impacting Americans' retirement?
Stephen Gilbert: Great. Appreciate you asking that question, Jenna, and Ruthann, I think you're spot on there. Obviously, we are dealing with some difficult days. The gears of the economy have slowed down greatly, unemployment's a big issue right now. Markets are certainly volatile. We're dealing with some of the lowest interest rates in history. Look, we're being put to the test, there's no doubt about it.
Stephen Gilbert: A matter of fact, according to a recent poll which was really a joint effort by Kipling [inaudible 00:05:03] and Alliance for Lifetime Income, what it turns out is after dealing with this pandemic, running out of money is one of the top concerns regarding retirement. Actually, it's only second to concerns about affording long-term care in retirement. [Source: A Kiplinger-Alliance for Lifetime Income Poll. “Americans & Retirement Security” September 2020]
Stephen Gilbert: And matter of fact, if you take a look at that same poll, half of pre-retirees are rethinking their retirement income plans because of the pandemic and the economic crisis. The same poll was shown at conversations between clients and their advisors, to be quite honest, between clients and their own family are greatly of consequence of what we're dealing with right now. So, what it boils down to is, this might be the perfect time to address these issues. Let's face it, a lot of us, we're still kind of barricaded in our homes, we're not commuting in and out of work the way we used to, we have a little bit more time on our hands. And if you think about it, Americans have had a 10+, 11-year bull run prior to this recent pandemic. And what it boils down to is they're more concerned with their finances today than they have been in a long time, and they have more time to work with it. So, I couldn't think of a better time to address these issues. [Source: Alliance for Lifetime Income. "2020 Retirement Reset Study Wave 3." July 2020.]
Jenna Dagenhart: And Chris, how you think COVID-19 is impacting the retirement industry itself?
Chris Previti: Well I think that it put more pressure on the industry, whether it be [inaudible 00:06:37] taking money out of their 401k prematurely through the [inaudible 00:06:41], maybe more than they anticipated, either to help their business or pay bills at home. Whether its people that thought about maybe working, close to retirement, what about working 5, 7, 10 years than have been forced to retire either by downsides and loss of a job. So, now got to dig into their retirement assets earlier than they anticipated. So, I think that the industry's got to get creative around, we used to solve for those types of people. How do you catch up after you've taken a large chunk out of your retirement assets? Or, how do you now plan for another 7-10 years in retirement where you thought you would be working for the [inaudible 00:07:29], right? And so, you haven't saved as much as maybe your goal was. So, the retirement industry, I think, has to get creative, and we can do that through a couple of different things.
Chris Previti: One, like Ruthann said, here at America, we've got an interesting perspective, we get to see both sides of it, too. We have a workplace part of our industry and then also an individual. You've got part to our business as well. So, I work on the individual side, so, when you look at the folks that are younger, I don't think there's a fact that it's much, I think that they are continuing to save where they can. My fear is that, potentially if they start making less money as companies, if this continues long enough, it's going to maybe put some pressure on payroll. And maybe they, instead of saving 10% like they used to but they dropped that down to 5, I think that's concern on long term for younger people. But I think pretty much they're pretty much status quo. It's the folks there that are closer to retirement, I think that this affects the most. And so, the industry's got to get creative around things like living benefits that provide long term, life time guarantee of income for clients. At a higher rate of what you can find out there right now in, we got maybe the buying market, fixed income market, right?
Chris Previti: And making that an asset class with a client where they can look at it like the equity is part of this asset class, fixed income is part of their asset class, and maybe in a new way they'll give you a benefit as maybe an asset class too to help pay for those expenses longer term then they may have anticipated. And I think, also, that clients are thinking more about their health. I think somebody mentioned that before. This pandemic hit everybody really hard and it was unexpected, and so people have kind of taken a while, now that they've been cooped up in their houses, to really re-evaluate their lives, and how do they want to spend their retirement, right? Do they want the house on the beach where their grandkids can come visit or is it just a matter of "hey, I'm complicit to where I am with my house and I just want to make sure that I don't have to worry about money again. And I want the kids and the grandkids to come here. Forget about the house and floor and where the island is, or that boat that I wanted," right?
Chris Previti: It's different for everybody, but I think it’s really has changed peoples' mindset of work versus home life. And what they need to do before the kind of life that they want to live moving forward. And that may be different that it was a year ago for them. But it's definitely put more of a pressure on the industry which is probably a good thing to get creative around solving for these issues that we really didn't have to solve for before.
Jenna Dagenhart: We have a lot of people doing a lot of deep thinking after COVID, and Ruthann, how do you think the industry has responded to some of the challenges associated with COVID?
Ruthann Pritchard: Not really sure I can speak for the industry, but I can, sort of, give you a highlight of how fidelity responded, and continues to respond to all of its clients, investors, and employees as well. And, I think it was said very well earlier, that in times of market stress and volatily, clients and investors want to have a conversation with somebody. So, our web use is way up as well, but everyone wants to hear a human voice and understand and get some help. So immediately following the crisis, we hired an additional 2,000 people to help do that and we continue to invest to meet the additional demand that we're seeing and engaging investors however we can. From a planned sponsor side, we continue to engage some of the way we always have, but we've also added webinars on HSAs, healthcare, the CARES act, as well as market insights. So really trying to help them on a number of different topics that they're facing as fiduciaries, and then lastly is an employee of fidelity.
Ruthann Pritchard: We were already well-versed in working remotely, but again, the organization stepped up and at one point, we had 90% of our employees placed globally working remotely from home. So, whether it was asset management or distribution, we all had tech-support, we always had regular communications, and so I think the organization itself is doing a great job.
Jenna Dagenhart: It's difficult to over communicate.
Ruthann Pritchard: It is, it's difficult to over communicate, but on the other hand, it's also been wonderful to still see everybody on Zoom and WebEx and still have that level of engagement with them.
Jenna Dagenhart: Definitely, and Steve, can you discuss the change in confidence, attitudes and behaviors of Americans since the start of the pandemic?
Stephen Gilbert: Yeah, I think we've done a pretty good job of, kind of, summarizing that, but the bottom line is, many Americans are at the peak of their financial concern, a matter of fact, take a look at some of the polls one of the recent ones [inaudible 00:12:55] income. It actually said 7 out of 10 pre-retirees are feeling more pessimistic about the retirement as a result of the COVID-19 pandemic that we're dealing with. Some of the biggest issues for them is, of course, is the unpredictability of the future, right? If you go back 6 months, we were on a very good path, maybe they felt they could predict things a little better, now this unpredictability is one of their biggest concerns, obviously coupled with concerns over, maybe continued market losses. I mean, if you think about this, the average baby boomer was really in their mid-fifties the last time they saw a crisis like this from a financial perspective back in 2008. That by definition means they're not in their mid-fifties, they're in their mid-sixties at this point. When you're mid-60s, approaching retirement, another downturn like this could be a real problem to someone's retirement plan. [Source: Alliance for Lifetime Income. "2020 Retirement Reset Study Wave 3." July 2020.]
Stephen Gilbert: A matter of fact, you kind of dig a little deeper into that poll, what is says is there's only about a third of Americans that are confident that they'll have enough income in retirement than cover the expenses in retirement. If you take a look at it, what it boils down to is you're also seeing folks saying they're more interested in levers in guaranteed income solutions. Look, we all know the demise of social security and the downturn and those being available to have a define benefit pension in their corner, so they're saying, "look, we're interested" and having a conversation about retirement solutions. So, we're seeing a pretty dramatic change in the thought process of how they're going to tackle their futures. [Source: Alliance for Lifetime Income. "2020 Retirement Reset Study Wave 3." July 2020.]
Jenna Dagenhart: And as a result of COVID-19 and the feds' aggressive monetary pulsing actions to try to stimulate the economy, we find ourselves in an extremely low-rate environment. Obviously, low-yields aren't ideal for investors relying on fixed income in retirement, so Chris, what are some creative ways to find income in this kind of environment?
Chris Previti: Yeah, sure. I think, there's 2 ways that I can think of off the tops of my head that I think make sense here. With constant pressure on the interest creates right now, and, it doesn't seem like there's going to be any relief there anytime soon, so the two suggestions that I would have is to look at either a variable annuity with a living benefit which will give you the upside of the market, and, without it being capped and potentially grow your asset. It also had an element of an income guarantee that will give you guaranteed income for life. So, the idea there is that you stay invested in the market, hopefully the market does its thing over time, you're able to lock in higher values to your benefit base. And when it comes time to take income, then you can the income off that benefit base, even if the market has taken a downturn. So, what it does, I think Ruthann talked about it before, was about people staying invested. What is does is it takes that fear of being invested in equities when times are rough. I mean, let's face it, it's easy to be invested in equities when the market goes up 9 years straight.
Chris Previti: I mean, it's hard to stay invested when the market's rocky, so, I think really the annuity with the living benefit, well it's really two thing for you. It helps you stay invested when times are tough and when it comes time for income, the worst thing that could happen to you is you decide that you’re going to retire and then maybe you want to start taking your income stream from your retirement assets. And a year or two before you’re ready to pull the trigger, the market takes a downturn of 230%. Like we saw in 2008. Think about all those people who retired in 2008 where their accounts were back in 2006. I bet if you could give them a chip and say, "hey! You go back in time a few years and we're hoping to place that chip on your retirement income," they would take that all day long, if they could lock that in. So that's really what an annuity does for you with the working benefit. It lets you stay invested, but then it also lets you put that chip on, kind of the high watermark they call it, where you're locked into market, okay, and now you can take your guaranteed income off of that high watermark, if you only have the market comes down by the time you retire.
Chris Previti: Also, fixed index annuity, we're seeing a lot more interest in the fixed index annuity market, a little bit of a different style of annuity from an investment standpoint because you're investing in industries rather than you are mutual sub accounts. Those industries are capped, so you're not fully participating in the market every year. There a cap range between 4 and 6% depending on the duration of the annuity. But you have a guarantee of principle there, so when the duration's up and if you decide to just walk away, you've got a guarantee of your principle which clients like. They're less expensive than [inaudible 00:18:31] with living benefits. Any they all show some of them have a living benefit component as well, so you've got a living benefit that's working for you in tandem with those industries. So, those are two places where I can see clients utilizing that to their benefit. And when it comes time to start thinking about retiring. My advice would be not to wait until you retire to make that investment in one of those two options. It generally, they're thought of as long-term investment options and a good strategy is 5 or 10 years out to be able to put the money into work in either one of those strategies. Let time take its course, knowing that you've got the guarantee that's holding up for you.
Chris Previti: And when it comes time to retire, it's there. Some people make the mistake of almost waiting too long and then they decide to retire, they don't let that money work for them, but then they buy the annuity and get the income right away. So, that would be my two suggestions.
Jenna Dagenhart: And Steve, I see you nodding your head over there. Anything you'd like to add?
Stephen Gilbert: Yeah, Chris, I think you had a lot of great comments there and, yeah, you're right Jenna. Nodding along because it's what we say a lot of times, too. When you think about risk, there's only certain things you can do with risk. And one of those things that you can do is transfer that risk to another party. That's what we're getting at there.
Jenna Dagenhart: And Ruthann, how is fidelity managing this low rate environment?
Ruthann Pritchard: I think the comments that Chris and Steve have made are great, maybe attack it from a little bit of a different angle? So that there's no doubt that some retirees are going to be challenged in generating a sufficient income. And that annuities, for many of them, can make a whole lot of sense. There's also market based strategies that might make sense for others. And so, in trying to navigate through those market-based strategies, we would say that a good strategy itself would be a, maybe let's make someone else make the investment decisions. So, whether its low rates or it creating income or if investors are concerned about asset allocation in general, finding a solution-based strategy may be the good way to go for them. So, from an advisor standpoint, we're seeing, as Steve said, those clients, having conversations with their advisors, and sometime they are very involved in financial wellness and overall financial planning. So, advisors are finding market-based solutions to invest in and spending the time with their clients. And, a similar story in the workplace. So, virtually, every defined contribution plan has at least one solution-based strategy, like a target date fund or a risk-based strategy.
Ruthann Pritchard: And more recently, strategies that are designed to help retirees in best and withdraw from their plans. For the majority of the employees and retirees, investing is not a core competency, or it might be but they choose to do something else. So, having these strategies in the plan, allowing participants to utilize these strategies than let someone else navigate the market is another way to approach all of these challenging times.
Jenna Dagenhart: And Steve, the current financial challenges that we've discussed: market volatily, unemployment, low interest rates, etc. coupled with longevity are forcing many people to figure out how to generate income for those longer lifespans during retirement. What's the solution here?
Stephen Gilbert: I think there is a myriad of solutions dependent upon who we're working with, what their goals are, what their objectives are. That's always the key in our business, is to know the individual we're dealing with, deal with their particular circumstances, but what is boils down to is really the management of risk. And, as I was saying earlier, there's only really a few things you can do with risk. You can try to avoid it, but there are costs associated with doing so, you certainly can retain risk, and that's reasonable and you may be rewarded for taking on that risk yourself. But there are levels of risk that people just aren't willing to have put on their own shoulders. And there's always the chance to transfer risk to another party. If you think about it, one potential concept of avoiding at least market risk is coming out of equities, right? However, there's a real cost associated with that. The safety might bring the risk of relatively low returns. As a result, this can obviously be a real problem if we're looking at a potential 30-year period in retirement. Sometimes we call this the "risk of losing money safely."
Stephen Gilbert: If we go into a safe mode, and we have 30 years of income to generate, once you back out inflation and taxes, you might not even have a positive real return, it may be negative. In over a 30-year period that could be extremely damaging. Of course, you can retain risk. Investors who neither avoid risk or decide to transfer risk, by definition, are retaining risk, and must manage their portfolios accordingly. However, they may be rewarded with potential higher returns for doing so. So, one can choose to retain the risk, like longevity risk and market risk, and more important than market risk really the retirees' secrets of return risk around the years of retirement, and certainly withdrawal rate risk. Obviously, that just leaves the last thing to talk about and that's transferring risk. And really, the opportunity to transfer risk to an institution that is set up to handle them. We ensure a lot of things, why would we not consider insuring at least a portion of our retirement income. Particularly again in those years as we're approaching retirement, and at the early years been retirement. Sometimes we call that the retirement red zone.
Stephen Gilbert: So, what it boils down to is there is an option to transfer risk. There are institutions that will take on that longevity risk, that market risk, the sequence of return risk, the withdrawal rate risk. Transferring risk cannot just help reduce the risk that's sitting on the client's shoulders, but potentially take pressure of the non-guaranteed portions of their overall retirement income plan. So, to kind of wrap back around to what you really asked me Jenna, I think part of the solution is having enough protected life time income to at least cover the essential expenses. There are certain expenses that we're just going to deal with in retirement whether we want to or not.
Stephen Gilbert: We're going to need food in our belly, we're going to need a shirt on our back, we're going to need a roof over our head, and I know there's a lot of Americans that think there's healthcare costs and return costs in retirement, I'm here to tell them that just isn't how it works. I don't know where that myth was spread, but you're going to have healthcare costs in retirement and you're going to want some transportation. There are certain expenses you're going to have to deal with and it would be a lot more comfortable knowing that you have the source of income to meet those expenses. And if we do it that way, maybe we can be more aggressive in our planning when it comes to discretionary expenses. The expenses, that if we really had to in a pinch, cut back.
Stephen Gilbert: That can give us a more aggressive standpoint, and that can be important, again, if we're looking for 30 years in retirement. I think if you take these strategies, along with some bucketing strategies that we work with to make sure that we're not too conservative. Yes, we're conservative for the dollars dedicated to the [inaudible 00:26:58] income, but let's go out a little farther out on a risk curve. For income, we need 10 - 20 plus years down the road. You couple those strategies along with very solid social security planning, healthcare management, long term care planning, along with good tax management, I think that's a good recipe to help you get there.
Jenna Dagenhart: And you raise a good point. We have flood insurance, car insurance, home insurance, why not retirement insurance?
Stephen Gilbert: You're right. Well if you look at it, for the average retiree, the top assets on average, I'm not saying all our clients are average, but you like at the average American, their number 1 asset in retirement is their house followed closely by their retirement counts. So, we know that we ensure a lot of things in our life, why would you not insure what would probably be your largest asset? [Source: United States Census Bureau; U.S. Department of Commerce, The Wealth of Households: 2017; Current Population Reports, By Jonathan Eggleston, Donald Hays, Robert Munk, and Briana Sullivan, August 2020]
Jenna Dagenhart: And Chris, are there any more important retirement considerations you'd like to highlight?
Chris Previti: Yeah, I mean I would probably say that I think, as far as longevity and our risk is concerned, I think you got to think about balance. You're still having a good balanced, well thought out portfolio, and when you look at, I think Steve mentioned good points about kind of laying off the risk to a company that's willing and able to take it. I think you got to start looking at how I think traditionally, people look at asset allocators as a mix between equity and fixed income. And, I think that now in kind of a new age of investing, insurance and annuity should be its own asset allocation. So, when people are looking to kind of silo their money and they say, "well, I think I should have this much in fixed income" when they're talking to their advisor and this much in equities. I think the conversation has to [inaudible 00:28:59] to, "how much do I need to put into an annuity product for long term income guaranteed the rest of my life? How much do I have to put in a long-term care product? And how much do I need to put in to some life insurance to make sure that family members, loved ones are protected as well. So, I almost think that needs to be its own asset class, and then you've got to diversify within that asset class. There's no doubt that there is a crossroad between wealth and health.
Chris Previti: And that crossroad really is, the richer you are, generally, the healthier you are. You have better access to doctors. Better access to prescription medication. Better therapy. All that kind of stuff comes with being wealthier. And conversely, if you look at it, the people that are healthier, they generally save more, their habits as far as saving are generally better than those that are unhealthy. So, I think that what you're seeing know with people living longer, a lot of it is the medical advances and drugs, but also, people are generally taken better care of themselves. And along with that, if they're taking better care with them, so they generally, there's been some studies out there that show that they are generally better savers, they think more thoughtfully about their expenses and how they're going to spend their money, and they generally make better choices with their money. SO, they're going to need that money to be there for a long time. If you’re going to live to be 100 or 110, and you're going to retire at 65, that's a lot of years. Some people may spend more time on retirement than they spend while they are working.
Chris Previti: So you're going to be able to afford that. And I'll go back to what I said in the beginning. I think that starts with a healthy balance and looking at things by asset class, and not just being stuck to the old investment model. Well, 50% in equities and 50% in fixed income should do me fine and I could take 4 or 5% out of that for life and I should be fine. I think we've all seen the Monte Carlo scenario over the years that all show that that all show that there is a probability, a good probability that that won't work out, especially if the sequence of returns when you're taking that money out, if you're taking your 4 or 5%, you start off with 2 or 3 or 4 bad years, it's very hard to recover as you are pulling an income stream off of those assets. So that's why it's important to diversify but also diversify into, as Steve said, into products where you're pushing off some of that risk to a company that's willing to take it.
Jenna Dagenhart: Yeah, and it's crucial to consider how much you're going to need to take out and when. On that note, Ruthann, how do you asses liquidity needs?
Ruthann Pritchard: Well I think Chris and Steve were spot on, right? When you're having a personalized conversation about individuals' needs, you're going to assess where or not an annuity makes sense or whether or not giving an investor full access to their savings makes more sense for them as an individual. I think when you look at the workplace environment, you've got a little bit of a different dynamic here because you've got to plan sponsor who's trying to create a defined investment lineup that's going to meet the needs of a variety of different cohorts. So, it becomes a little bit more challenging, and in that particular environment, we found that from a liquidity standpoint, full liquidity is important to the planned sponsor, and it's important to the participant themselves. So, in market right now we have what we call the "managed retirement funds." And it can be paired with a managed cash flow withdrawal strategy that's actively managed by our investment team. So, it gives them a life time income, it gives them life time balance, so there's money left over at the end, and it also gives them full Equity so they can meet those unexpected needs that have been talked about, like healthcare, like traveling, or helping out your children.
Ruthann Pritchard: So, that's the way we've gone about addressing it for now in the workplace situation. And it seems to be really taking on a life of its own which is good to see.
Jenna Dagenhart: To quickly follow up on that, you say that the managed cash flow is actively managed. Could you elaborate on what that means?
Ruthann Pritchard: Yeah, and I think Chris said it very well. I mean, you can't just set it and forget it, right? The withdrawal strategy itself is percentage based and it varies by the age of the investor and the account balance. So, it's meant to be paired with the asset allocation of our managed retirement funds. And in concert with each other, they are designed to achieve that stable lifetime income for the investor, give them a lifetime balance with assets at the end, and provide full equity. So, when you're thinking about developing something like this, you have to consider the payment rates themselves as well as the asset allocation of the funds.
Ruthann Pritchard: And a higher payout rate today may mean you don't meet the end goal of having a balance, focusing too much on the stability may mean that you're foregoing other returns that could have otherwise been achieved. Longevity, every individual is going to have a different life span and retirees are indicating that they want that final balance, but they don't want to much at the end, that means they could have spent more, and they certainly don't want to run out of money. So, in creating the cash-flow strategy itself, there's an awful lot of judgements in tradeoffs that need to be made.
Jenna Dagenhart: Yeah, and I know we've discussed this somewhat but I want to take a closer look at the tools used for retirement planning. Steve, there's a lot of uncertainty, to say the least, when it comes to retirement itself, so, how do different products help people plan for whatever retirement might bring?
Stephen Gilbert: That there's a lot of uncertainty when it comes to retirement. A matter of fact, even the USGAO has come out and said, "the three pillars of retirement income: social security, employers' sponsored plans, and their own savings is no longer providing adequate retirement income for a growing number of Americans." If you take a look at social security for a minute, the last report of social security mistakes in 2035, [inaudible 00:35:56] a fraction the revenue required to pay off benefit, and I want to put that in context, that's before the unemployment issues we're dealing with today. You all know how social security is funded, it's funded through predominantly payroll tax, we know what unemployment looks like, and what that means is, social security is not benefiting from the current situation. So, no crystal balls, my guess is we're not going to see a rosier picture in the next report that comes out. One has to wonder really what the changes in social security might look like. If you're coupled out with concerns regarding healthcare costs, market volatility, and then the point we've been talking about, the bit here is the length of time that we'll need to generate that retirement income check, it certainly does build a big feeling of uncertainty. [Source: U.S. Government Accountability Office “The Nations Retirement System: A comprehensive re-evaluation is needed to better promote future retirement security.” October 2017 https://www.gao.gov/assets/690/687797.pdf]
Stephen Gilbert: One of the keys, to answer your question, to manage the uncertainty, is to build a flexible and diversified retirement income strategy. Like I said, there isn't a cookie cutter, one answer fits all. We really need to be diversified with it and build a plan that's flexible because things will change. If we're looking at 30 years of retirement, even the best of income planners who have thought about every contingency, there are a lot of variables that go into that processes, and odds are, one of them is going to change over 30 years. So, to build it as flexible and diversified as possible is really the key. And one of those strategies if the bucketing strategy, as I mentioned earlier, look we don't want to be in that position where we lose money safely. Sure, we want to be conservative for the assets dedicated to our income and near future, but look, odds are our clients will still be alive 10, 20 years down the road, and yes, they'll need income, but we can target more aggressive strategies towards the income made needed further down the line.
Stephen Gilbert: You combine this with some of the newer products out there, now we talking a little bit about different types of protective lifetime income, every year they seem to be getting more and more flexible, so, if you work with a product that, not only can prove you that [inaudible 00:38:22] income, maybe take pressure off of some of the other assets. But one that is flexible in of itself, one that'll allow you to stop the income stream, start the income stream back up and bank income that you're not making, those types of flexibilities really lend to working with the client as things do change. What it boils down to is there are a lot of different products out there. The matter of, again, knowing the clients and knowing their situation, and then fitting them a product that fits them the right way. If you couple some of these strategies along with some of the products that are now available out there. Again, along with good long-term care planning, to address healthcare, saving accounts, addressing some of the healthcare issues. I think you start to design a plan designed to help with these uncertainty issues in retirement.
Jenna Dagenhart: And given this need for flexibility, how are retirement income products evolving, Chris?
Chris Previti: Jenna, I believe that they are evolving a lot in this day and age. They are becoming much more flexible. The older retirement products I think were rigid, people brought them, they generally stayed in them for a long period of time and during that time as their needs changed and evolved, the retirement product generally didn't change with those needs. So, it was kind of one shoe fits all. With today's retirement products and tomorrow's, the need for flexibility is pinnacle. I believe that what you're going to see is a [inaudible 00:40:04] that change over a client's investment lifetime. So, what's important to a 35 or 40-year-old may not be important to a 55 to 65-year-old, and those may not be the same needs that are important to a 75 or 85-year-old. So, I think what you're going to see is products built with a lifetime journey of investment in mind. One that they could accumulate market gains over time and stay invested like they should and lead to a couple of different avenues, if you will. So, a younger client may be interested in personal guarantee. So, they want to invest they want to take advantage of the market, but they don't want to lose any money.
Chris Previti: So, maybe they start in the personal guarantee fields. Then they get a little bit older, now they're in their 50s and they're starting to look retirement in the face, and they decide that personal guarantee maybe isn't as important as lifetime income. So maybe they choose that they want to flick that switch on for lifetime income. And maybe they get to the point where they retire and they don't use the retirement income feature, then they switch over to and flip the switch on to a death benefit that will leave a legacy with them for their kids or their grandkids. So, I think they're going to have to be nimble, I think they're going to have to flexible, and also, this day and age that the way clients like to invest inside wrap accounts where everything in kind of wrapped together and all their investments are in one place, the flexibility in those types of accounts are crucial. And I think where [inaudible 00:42:01] are going and where we want to be as an industry is inside those feed based wrapped accounts. And in order to do that, we're going to have to be as flexible as well as the other investments inside of the wraps.
Jenna Dagenhart: And Ruthann, broadly speaking, what exactly are you seeing from an asset allocation perspective on the fidelity record keeping system? And on top of that, do you have anything in market for these participants?
Ruthann Pritchard: Yeah, absolutely. And I couldn't agree with Chris more that the income that a retiree needs, needs to flexible. And the other part of that income solution is the asset allocation of that individual investor. So, when we look into the workplace or the record keeping system, we have a graphic here the shows exactly what we are seeing today. So, the x-axis is the age of the individual, the y-axis is the percentage of equity in that participant's portfolio, and the green band that you're seeing is the percent of participants of any age that are within plus or minus 10% of their target date funds equity allocation. So, generally meaning something a planned sponsor would therefore consider a reasonable equity allocation. So, if you start on the left, the youngest participants, the band is very wide. Many of these participants have benefited from auto-enrollment and being defaulted into a solution like a target date fund. As you move to the mid-right, you get to mid-career and the band starts to shrink, and some of those are very appropriate. Perhaps the circumstances are different and life can get a little more complicated and they've also never benefited from auto-enrollment. But they also may not have been rebalancing within the last 10 years, so if you look just above the green band, you'll see that the higher than equity allocation is left to grow even higher.
Ruthann Pritchard: And then as you move further to the right, towards and beyond retirement, you see that even fewer are what might an appropriate range and in that band. And it may be because they have other assets, they have a spouse. But it also could be, just in attention, to their asset allocation or the lack, or desire, or knowledge to change that. SO, you'll see here, the higher equity allocation continues to grow and from a disappointing standpoint, retirees also move to 100% cash and you can see that 0% equity bucket also grow. And knowing that you have to fund the 25 to 30 years in retirement that we've all been talking about, that's something we want to correct. Our managed retirement funds that I talked about earlier are meant to help reset the asset allocation of all of those participants, and not only provide them with an income and withdrawal strategy, but also give them an asset allocation that can last the throughout retirement.
Jenna Dagenhart: Steve, how are financial services' companies evolving to help meet new challenges?
Stephen Gilbert: Well if you take a look at the financial services company and what they're doing, they're building newer, and as you mentioned earlier, more credible products more aimed at really helping the clients meet these challenges. I mean, if you just take a look at the protective lifetime piece of things for a moment, the range of different types of products you can find today is light years just 5 to 10 years ago. You can look at products that provide protective lifetime income at extremely high levels, maybe a little less upside, but extremely high levels of income really designed for folks that want to deploy as little as their capital as possible to generate the income needed. If you can get the same income job done, but do it with less capital, you free up the assets to achieve other goals. And certainly, you can find the opposite, too. You can find a protective income lifetime product. It might be a little bit lower levels of income, paid out in a guaranteed fashion, but give a bit more upside potential too that. The products where they're not income oriented at all. Really what they are designed to do in particularity in that retirement red zone we're talking about earlier, protect us really from a market exposure, from sequence of return risks, as we approach retirement or early on in retirement.
Stephen Gilbert: And some of those products, the ones that aren't necessarily geared towards income but more geared towards protection from a potential downturn in the markets. That would be the excellent solutions in the bucketing strategies. As Chris mentioned earlier, you particularly want to be careful in those delicate years right before retirement. These products that we give you on an assemblance of market or equity types return, but with the guarantee that you're going to have to recognize any market loss. That could be perfect for levitating someone those retirement risks in that red zone. So, [inaudible 00:47:30] Chris to your point, I don't think its ended yet. I think we are going to continue to see these products evolve over time, become more flexible, and provide us with more opportunities to put those strategies together.
Jenna Dagenhart: And Chris, in this new environment, what are you finding as most important to clients approaching retirement?
Chris Previti: Well I think from I see from advisors and clients around the country over the last 12 months is really 3 things. First is preservation of assets. The preservation principle is really at the top of peoples' minds right now. They've had a nice 9 or 10 year run and their accounts, if they've been invested in [inaudible 00:48:20] are way above what they started with. And I think that there Is starting to become a little bit, a feeling of when is thing going to take a downturn? It slowed down a little during COVID but then popped back up. And I think that in general, most clients are thinking themselves and asking their advisors the time to take a little bit off the table. So, Steve's point of personal guaranteed products have become very popular in our industry and its what clients and advisors have been looking for. The way to take some money off the table without "taking it off the table." They are able to move it in equity, style investments from sub accounts and continue to capture that upside if it should run another 5 or 10 years, which we all hope it does.
Chris Previti: But if it doesn't, it takes some downturn, they have some sort of principle guarantee through a duration. I think fixed in annuity is covered that same premise, you get to play the embassies but then also, there's a principle guarantee element to that, you're kept on the upside, but you know you're going to walk away with your principle so that's an avenue as well. The second is guaranteed income. I thinks it's always on people's mind. They are worried about living, or outliving their income and living too long. They are worried about how they are going to pay for their basic essentials, but then they are also worried about "how am I going to pay for [inaudible 00:50:01] healthcare, and prescription medications" and all that kinds of stuff. So, there's always that concern and that's on their minds as well. And last is really the long term care / healthcare element to that, and that's why I said before that I think the companies that find a way to marry some type of retirement like product with long term care, where you have maybe an investment that you're participating in and maybe a benefit that's got a long term care element to it that as the, as your investments to well, you could lock in maybe more portions of long term care or more of your benefit goes towards long term care. Something that will keep pace with the rising cost of long-term care as well.
Chris Previti: And that goes back to flexibility. So, you're not buying an actual long-term air policy that you're locked into and you never go into a facility and you never need long term care. This way, you've got really a few different [inaudible 00:51:18]. You're invested and if you decide that you want to walk away at some point, you've got that ability, but you also know you're covered for long term air down the road and hover for the rising cost of that air if the market performs. So, it's almost like a bearable life. Where, you hope the market knows what the market should do and it starts to cover your premiums. It really, if you think about it like that, a product that can solve for that, I think would be very attractive to most people out there and it’s a concern,
Jenna Dagenhart: And before we wrap up here, it wouldn't be a retirement income masterclass panel if I didn't talk about the secure act which creates a safe harbor for annuity selection with the goal of increasing availability of these products inside 401k plans. Chris, how do you expect this will change the market, if at all, and what's the future of that opportunity?
Chris Previti: I think it changes the market huge. I think it's a huge opportunity for 401k owners. Having an annuity as an asset class, especially an annuity that offer benefits like death benefits, your living benefits [inaudible 00:52:38], I think it's great for them, I also think it's great for our industry. Annuity industry, we don't get to touch as many clients as the investment, our partners in mutual funds and fixed income portfolio we get to touch. There's a certain demographic that chooses to purchase [inaudible 00:53:04]. So, this opens up the door, kind of get their feet wet for younger investors that aren't familiar with annuities or how they work. And I think really the big key there will be education. The workplace companies that are in that marketplace, being able to educate the participant about the annuity investment in 401k and what opportunities that they can take advantage of with an annuity. I think for a long time that annuities, they seemed to not fit into 401k. People were buying them for the tax-referral element. In the last 20 years, I would say that about 95% of annuity purchasers buy the annuity for the benefits that are associated with it, whether it be living, death, principle guarantee, whatnot.
Chris Previti: And a lot of our assets that flow into the industry, about 65% of them are IRAs because you're not changing the capability. It really makes sense to be able to offer that. Inside of a 401k retirement plan as an option so that younger clients can figure out for themselves what are their goals, and if it is principle guarantee, and they have that as an option on the annuity in the 401k, maybe they put some of the allocation towards that id that's what's important to them. If they're a participant and they are starting for [inaudible 00:54:51] retirement in the next 5 or 10 years, maybe it's an annuity with a living benefit option. Or if they've got plenty of money and they're not really worried about the last two points that we've made, maybe they're more worried about children and grandchildren, and they make sure that they leave a nice nest-egg for them and maybe it's utilizing the death benefit in the scenario. But I will come back to education because if annuities are complex investments and they've got a lot of moving parts, and I would hate to see people miss the opportunity to invest in annuities because they didn't realize the benefits that were associated with them and that's all you’re going to come to the proper education.
Jenna Dagenhart: Ruthann, over to you. How would you explain the implications of the secure act?
Ruthann Pritchard: I completely agree with Chris. So, I really think it paves the way for a lot of innovation in the industry and we, like everybody else, are obviously trying to find solutions that can solve everything Chris was just talking about. That it's good for the fiduciary, it’s good for the planned sponsor, and it's good for the participant, and it’s something everybody can understand, and that there's education and communication to make everyone feel comfortable with the solution and give them the confidence to invest them in. I think we've got out a ways to go. But definitely paving the way towards innovation and getting these types of guaranteed products in 401k plans.
Jenna Dagenhart: Steve, anything that you'd like to add about the secure act and looking ahead, do you think guaranteed income will become more of a priority for people?
Stephen Gilbert: Yeah, if you think about the secure act, the good news is, is that most of the news is positive, most of it is something we can be happy about. If you think about the secure act, it’s really the biggest piece of legislation affecting retirement since the pension protection act back in 2006, it's been over a decade now. And as we discuss the pillars of retirement, they aren't what they used to be. Social security isn't on the footing that we'd like it to be, pensions aren't as prevalent as they used to be, and what that means is a more pressure on the individual on the planned participant, to generate their own income, and as was alluded to earlier, historically, when you look at the predominance that retirement plans offer today, they don't have those income solutions when the clients retires, and it makes you wonder well should we really call them retirement plans, maybe we should just call them accumulation plans because it’s hard to call it a retirement plan but it doesn't have a solution for retirement. So, what it boils down to is I hope some of these provisions do what they are intended to do.
Stephen Gilbert: We saw a massive increase in the tax credit available to the small business owner for establishing these plans. Hopefully that's enough to get more small business owners to establish these plans. We saw laws that were geared to getting those long-term part term employees involved. I hope you see them saving better for their retirement. And what it boils down to, of course, a great opportunity to see annuity more included in these plans. And why would you do that? You would do that for all the reasons you discussed earlier. The idea of transferring some of these risks off of the client's shoulders onto the back of an institution designed to manage risk. But I do nave good news with a little bit of reality when it comes to legacy planning, and that is, this act massively changed. How the legacy act worked when it comes to our retirement accounts, IRS. You know, we used to feel pretty comfortable, our kids would be able to stretch out our IRAs [inaudible 00:59:00] over the whole lifetime. We only know that for the most part, that isn't going to be the case. In most of the scenarios, our kids are going to stuck in trying to distribute everything in 10 years.
Stephen Gilbert: That is something that needs to be addressed. We need to get in front of our clients, do those beneficial reviews, have the conversation about where the secure act has gone, and then talk about some strategies to help alleviate those concerns, which might involve some charitable gifting concepts, concepts regarding, potentially [inaudible 00:59:36] being a little more prevalent. All things that need to be discussed, because to be honest, we've been dealing with a lot of the country in the last few months. The secure act came in at the very end of last year. I don't think we've really given it due diligence. I think we need to continue to have that conversation about the secure act with our clients so they truly understand all the effects and how its changed, and how their planning will work in the future.
Jenna Dagenhart: And Ruthann, as the largest record keeper in the country with one in four defined contribution participants in the country on your platform, how does fidelity think about retirement income moving forward. What are the key risks, key factors you consider?
Ruthann Pritchard: I think there's different cohorts on the record-keeping platform. There are those that do it yourself, those that are responsible for their own asset allocation, so I think retirement income for them needs to mean within the context of the defined contribution plan, having options that help them achieve retirement income. Then you've got managed accounts. So, having availability to your participants for them to get a more personalized solution that can help them generating retirement income and withdrawal strategies. And then there's the managed retirement funds and their solutions that are for those that don't want to invest in a managed account and don't want to do it themselves, and have flexible options for those participants to address their retirement income needs. Because, what we're really hearing is that longevity risk, we've talked about it, that's sort of number 1, they don't want to outlive their money. Another is asset allocation; they don't know how to appropriately invest for a retirement. And liquidity, we've talked about that one as well. And then utilization. So, our research really indicates that if a participant doesn't feel confident enough to retire, they won't retire, which of course creates workforce management issues for the employer. And then when they finally do retire, they generally spend less than they could because they just don't know how much money they can spend.
Ruthann Pritchard: So, I think from a workplace standpoint, there's lots of work to do and lots of innovation that's coming down the pipe right now, and hopefully we'll be able to address the needs of all these different cohorts.
Jenna Dagenhart: Chris, the general view is that consumers will have an even stronger [inaudible 01:02:01] to opt for income guarantees, regardless the priceless endemic to low rates Please share some perspectives on how things will change, or perhaps won't need to, moving into 2021 to capture this opportunity.
Chris Previti: I do believe that the need for guarantee income type products will remain at a high level, given where interest rates are. There becomes a point, thought, from a pricing standpoint where you've got to start easing up or [inaudible 01:02:42] ease up a little bit on those guarantees. So, you'll see those levels of income start to come down. My concern at times is, when you've got interest rates that are almost at 0, you're able to offer 4 1/2 to 5%, that's fine. I think you've got such a value gap there that clients are still, believe that they can purchase annuity with a living benefit and still see the value in it over time. My concern is that is rates stay low for a long period of time, the pressure that puts on insurance companies to be able keep those rates that, what I would say, a position of value is going to become tougher.
Chris Previti: So, a couple things. I think that, yes, there is a need for products, and I think that as long as there's value in that guarantee, there'll continue to be a need, but I do believe that there's a threshold to where advisors and clients, if those guarantees dip too low. In the 3s or below the 3s where they won't look at it as being as valued. Or, granted, if you can go out and built a bond portfolio or you can buy a fixed income fund and be able to get 3 1/2 or 4% yield back on your own, then the value of that living benefit, it's diminished greatly. So, right now the value gap is big, it's actually bigger than it was, 10, 15 years ago. Even though the benefits have come down a bit, I think about 6% used to be the norm 10 to 15 years ago, and then 5% guaranteed income for life came in norm over the last 10 years, I would say. And that's kind of the number. Once you start dipping below 5%, people start to look at all their strategies like I mentioned before. As long as you're at that 5% level, that's great.
Chris Previti: That was given, though, back then with interest rates of 3%, right. So now you've got living benefits that are still around 5%, but look what interest rates are now, they're close to 0. When you're at a tenure hovering around 60 basis points, all of a sudden, even if the benefit goes to 4 1/2, 4 1/2 looks very good versus 60 basis points. Better, probably than 6% looked at, looked like 10 years ago versus 3% tenure. So, it's all relevant, and it’s just a matter how long we're going to see rates at this level, and how long the insurance companies are going to be willing to write that type of business with the pressure that it puts on. And for now, I think that there's a lot of value in them and I think that clients see the value in them as well.
Jenna Dagenhart: Well a lot of important considerations. We could Clearly talk about retirement all day, but we better leave it there. Everyone, thank you so much for joining us.
Chris Previti: Thanks for having us.
Jenna Dagenhart: And thank you for watching this retirement income Masterclass. I was joined by Ruthann Pritchard, institutional portfolio manager at Fidelity Investments, Chris Previti, managing director of distributions for individual solutions at Trans America capital, and Steve Gilbert, director of advanced planning at Prudential Annuities. And I'm Jenna Dagenhart with Asset TV.