When BlackRock chief executive Larry Fink warned of a looming “retirement crisis” this week, he not only drew attention to a long-rumbling societal problem but also highlighted a business opportunity that his money manager, its rivals and insurers are all hoping to cultivate.
Countries around the world are struggling to fund old age benefits as longevity increases, but the US has a particularly acute problem, as more than 4.1mn Americans retire annually — or a predicted 11,200 people each day, between now and 2027.
The $38tn US retirement system is one of the world’s largest, and US employers were among the first to shift from defined benefit pensions to defined contribution plans. Starting about 40 years ago, they essentially transferred responsibility for funding retirement from employers to employees.
Many affected workers — who are now expected to live longer than previous generations — are facing the serious likelihood that they have not set aside enough money in 401k plans, which encourage workers to put money in tax-advantaged accounts in exchange for an employer match.
Even those who have substantial savings find it confusing to manage their pension pots while ensuring the money does not run out.
“We are at a critical crossroads. Millions of Americans are at risk of running out of savings in retirement,” said Catherine Collinson, president of the non-profit Transamerica Center for Retirement Studies. “It’s a societal test — how will we help those who are ageing in their time of need, when they no longer have resources available to them?”
At the same time, employers who sponsor defined contribution plans and the asset managers who run them are waking up to the financial advantages of keeping retirees’ assets in house. BlackRock, Franklin Templeton, T Rowe Price, State Street and JPMorgan Chase are among those working on new products aimed at helping retirees with what is known as “decumulation”, a process that economist William Sharpe called “the nastiest, hardest problem in finance”.
Fears about the US retirement system have been swirling for years, as the working-age share of the US population falls and more retirees live into their 80s. The trustees in charge of Social Security, the government retirement programme, estimated last year that it would have to start cutting benefits in 2033, unless Congress raised the retirement age or levied additional taxes.
Fink’s letter nodded to this long-standing issue, saying that societies needed to encourage people to stay in work longer. “It’s a bit crazy that our anchor idea for the right retirement age — 65 years old — originates from the time of the Ottoman Empire,” he wrote.
The ageing of Generation X, born between 1965 and 1980, has crystallised these concerns, because they are the first workers to rely heavily on 401k plans.
Because such plans were originally envisioned as supplements rather than replacements for final salary pensions, participants have an enormous amount of choice about whether to participate, how much to put in and where to invest. The plans also force workers rather than employers to absorb market risk. Studies show that many individuals fail to enrol, take money out when they change jobs or chose overly conservative options.
“All the risks have slowly moved over to the participant . . . Investing has gotten a lot harder, inflation has come into play, people are living longer and there’s a real possibility of running out of money,” said Timothy Pitney, head of lifetime income sales at pension provider TIAA.
Most Gen Xers have 401k plan balances that are woefully inadequate to fund a long retirement. The median Gen X household has just $40,000 saved for retirement, and 40 per cent of all 401k accounts have a zero balance, according to the National Institute on Retirement Security.
“Gen X is emblematic of where we are heading and things don’t look very good,” said NIRS research director Tyler Bond.
Even people with well-stocked 401k accounts are running into trouble because most plans have not put much emphasis on helping participants make efficient use of their savings. Between banks, 401ks and other investments, the average person has seven different accounts when they retire, some subject to tax, others not.
“We are going to have a ‘world is not flat’ moment, when asset managers are going to realise we are not prepared to help people draw down,” said Bill Meyer, CEO of Retiree Inc, a retirement planning software company owned by T Rowe Price. “Drawdown is not simple. It’s like a Rubik’s Cube.”
Many workers wish for the simplicity of a pension that does not run out: 73 per cent of workers surveyed last year by insurer Nationwide said they wished their 401k plan had a lifetime income option. “The notion of a guaranteed pay cheque, that you can’t outlive your savings — people want that,” said Anne Ackerley, head of BlackRock’s retirement group.
Until recently, the only way most 401k participants could get such income was to leave their 401k plan and buy an annuity from an insurer. Those are sold through brokers, who charge up to 6 per cent commission and, unlike 401k managers, are not required to act solely in the interest of the customer.
Now that Americans have amassed $10.6tn in defined contribution plans, asset managers and plan sponsors are trying to hang on to those assets for as long as possible by offering the income products inside the wrapper of retirement accounts.
“Many plan sponsors would prefer to have the money stay in the plan,” says JPMorgan’s head of retirement Steve Rubino. “We are genuinely reaching a tipping point.”
State Street Global Advisors developed a new product for the $32bn University of California retirement system aimed at this issue. It pairs a “target date” fund, which lets workers pick when they want to retire and automatically invests their contributions in a changing combination of stocks and bonds, with an optional annuity that starts annual payments 15 to 20 years after retirement. Retirees can feel comfortable using savings because they have guaranteed income coming later.
“The annuity is an insurance policy against outliving one’s assets,” said Brendan Curran, SSGA’s US head of defined contribution. “Bridging the spending and savings gap that exists today [is] the next frontier for 401k design.”
But asset managers said they were fighting a battle with customers who have a negative association with annuities as expensive, complex, and illiquid products. “People hear pay cheque for life, they think ‘great’. Then they hear the word annuity,” Ackerly said.
BlackRock’s LifePath Paycheck, which rolls out in April, also combines target date funds with annuities, but the guaranteed payments can start sooner, allowing participants to keep the rest of their pension pot in higher risk, higher return assets such as stocks.
“I don’t know if annuities are the future, but they’re a missing piece. They can help supplement what defined benefit plans used to do,” said TIAA’s Pitney.
Such programmes can boost asset managers’ revenue and reduce stress for retirees who already have pension pots. But they cannot solve the larger problem of workers who have been unable to save in the first place, retirement experts agree.
Congress has passed two laws, known as Secure and Secure 2.0, to widen both access and the use of 401k plans and make it easier for workers to qualify for an employer match. New plans must automatically enrol participants, and many gradually increase the size of individual contributions. About 20 states have also set up defined contribution plans for workers at small companies and the self-employed.
BlackRock’s Fink called this week for further reforms, however, writing: “America needs an organised, high-level effort to ensure that future generations can live out their final years with dignity.”
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