Module 8 Impact of Financial Product Innovation on Retirement Plans

Question 1

What are some of the factors that have come together recently that focus on the need to help older workers convert the DC retirement plan balances to periodic income?

Answer 1

1) the majority of older workers to not have access to retirement income solutions in their 401(k) plans
2) lifetime income options be added to DC plans
3) regulatory developments are enabling the use of retirement income solutions in tax qualified DC plans
4) older workers need and want help with developing retirement income
5) new regulations require financial ladvisors and institutions that provide advice regarding tax qualified retirement accounts to act as fiduciaries
6) reports show how employers and financial institutions can construct retirement income programs in DC retirement plans and demonstrate analytical techniques they can use to help them design these programs

Question 2

What are the major challenges older workers confront when they need to convert their DC plan assets to periodic lifetime income?

Answer 2

1) retirement savings may need to last anywhere from 20-30 years
2) market volatility adds another level of complexity to the task of managing savings in retirement
3) many older workers are unable to accurately calculate the amount of savings needed to generate lifetime retirement income
4) not many retirees have a formal strategy for howt o draw down their savings
5) many older workers with moderate savings do not have access to skilled and unbiased finanical advisors, or they may not know how to identify and select them
6) older workers looking for retirement income solutions face a rapidly evolving marketplace that is difficult to navigate

Question 3

What are some typical retirement income goals?

Answer 3

1) a desire for liquidity to meet emergencies
2) maximizing expected retirement income
3) income that does not decrease due to capital market volatility
4) income that keeps up with inflation
5) income that retirees cannot outlive

Question 4

What were the results of the SOA/SCL study providing an analytical framework for planning retirement income?

Answer 4

1) there is a distinct, quantifiable trade off between liquidity and maximizing income
2) for most retirees, using a portion of retirement savings to delay SS benefits increases expected total lifetime income and helps protect surviving spouses
3) once a retiree achieves a basic level of guaranteed income, optimal solutions could significantly invest remaining assets in equities
4) required minimimum distributions can be a reasonable solution that can be implemented with ease by plan sponsors and retirees
5) funds fully allocated to target date funds right up to retirement render older workers vulnerable to stock market crashes
6) combination solutions that generate income from invested assets until an advanced age with qualified longevity annuity contracts delivering income thereafter can be difficult to implement as a ‘set and forget’ solution

Question 5

The SOC/SCL research project supports a retirement income menu design with at least three destinct retirement income generator (RIG) options. What are these three options?

Answer 5

1) a systematic withdrawal program from invested assets in the plan
2) guaranteed lifetime annuities offered by an insurance company
3) a temporary payout from plan assets that enables delaying social security benefits in order to increase total retirement income

Question 6

Plan sponsors that want to help retirees convert DC plan assets to retirement income while recognizing their fiduciary duties will want to conduct a due diligence process that includes which steps?

Answer 6

1) assess the needs and abilites of their older workers
2) learn about various RIGs including the retirement planning goals each RIG addresses, their advantages and disadvantages, and how much income can be reasonably expected
3) learn about the capabilities, costs and communications support that can be provided by their existing plan administrator and the capabilities of alternative vendors
4) develop criteria for the design of the retirement income program, and assess how each potential RIG and retirement income solution meets these criteria
5) develop a reasonable timetable with the plan administrator for implementing and communicating the retirement income program

Question 7

Describe the regulatory suggestion made in the SOA/SCL study for helping retirees convert DC plan assets to retirement income

Answer 7

The study suggested a Safe Harbor guidance during the decumulation phase which would be analogous to the safe harbors that apply for investments during the accumulation phase

Question 8

What are the advantages to retiring employees of an employer sponsored program of taking retirement income from a DC plan?

Answer 8

1) Institutional pricing has the potential to increase retirement incomes by 10% to 20% compared to retail solutions
2) Solutions are more likely to be implemented successfully if it is easy for retiring and employees to implement their decision
3) The employer’s plan is a safe place to keep retirement savings away from fraudsters who target seniors

Question 9

What is the basic purpose of QLAC?

Answer 9

QLACs provide retirement income to individuals starting and an advanced age. They provide financial security to retirees in case they exhaust the retirement investments.

Question 10

What is the regulatory obstacle that, in the past, prevented the use of longevity contracts?

Answer 10

The IRS required that the value of any longevity contract must be included as part of a participant’s account balance for RMD purposes. The final regulations provide relief from the situation by allowing participants to exclude the value of the longevity in annuity contract for RMD purposes if the annuity meets the definition of a QLAC.

Question 11

Do all types of retirement plans qualify as QLACs?

Answer 11

Only DC plans (including 401(k) and profit sharing plans), traditional individual retirement accounts (IRAs), 403(b) plans, and government 457(b) plans are eligible to hold QLACs

Question 12

What are the contract features of QLACs with regard to (a) the maximum premium that can be paid, (b) the maximum age to commence payments, and (c) prohibited contract features?

Answer 12

(a) The total premium cannot exceed the lesser of $125,000 (indexed for inflation) or 25% of a participant’s aggregate account balance
(b) The maximum age at commencement of a QLAC is currently set at the age of 85
(c) The following features are currently prohibited: variable contracts, indexed (or similar) contracts, and contracts with commutation benefits or cash surrender values. In addition there are restrictions on the death benefits that can be available under a QLAC contract

Question 13

What are other required features of a QLAC?

Answer 13

• Must contain specific language in the contract that Identifies it as a QLAC
• QLACs are subject to an annual reporting requirement that includes information about the plan and plan sponsor, the annuity starting date, the amount of the payment, and whether the starting date may be accelerated

Question 14

Must ERISA investments always follow mainstream and popular strategies to be considered prudent?

Answer 14

This is a belief held by many but it is not true

Question 15

What are the differences between baseline prudent investment practices under ERISA and enhanced ERISA best practices for innovative investments?

Answer 15

With section 404 Congress mandated baseline or corporate practices for all ERISA plans using even the simplest of investments. The enhanced fiduciary best practices for innovative investments are a second and necessarily deeper layer that magnifies the baseline. This secondary supplemental standard has been created by intermittent publications from the Department of Labor.

Question 16

What 2 parties must be served when selecting planned investments?

Answer 16

The participants and their beneficiaries

Question 17

What are the responsibilities for fiduciaries have when setting up a monitoring system for the fees associated with an investment per the DOL?

Answer 17

1) Determines the needs of a fund’s participants
2) Reviews the services provided and phase charged by a number of different providers
3) Selects the provider whose service level, quality, and fees best match the fund’s needs and financial situation

Question 18

What is the ‘prudent man’ standard required of ERISA plan investments?

Answer 18

The ‘prudent man’ standard requires investments to be made ‘with the 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.’

Question 19

What is the relationship between modern portfolio theory (MPT) and the diversification requirement in ERISA?

Answer 19

Since MPT is a bedrock tenant of ERISA the diversification requirement is very important. It reduces the risk of large losses by diversifying the investments of the plan so as to minimize the risk of large losses unless under the circumstances it is clearly prudent not to do so.

Question 20

What are the features or characteristics of a good investment policy statement (IPS) for innovative investments?

Answer 20

1) It should be more detailed than an IPS for standard investments to help assess the innovative investment and most importantly to help monitor the innovative investment on an ongoing basis
2) It should be flexible enough that it can be implemented in a complex and dynamic financial environment
3) It should not be so detailed as to require constant revisions and updates
4) It should be drafted in a way that does not increase the risk of failure by the investment fiduciaries
5) It should be carefully drafted typically by an attorney familiar with employed benefit issues working in concert with the fiduciaries and their investment consultants
6) The investment criteria in the IPS should be written in the context of meeting the needs of the participants

Question 21

Does poor investment performance constitute imprudent investment management under ERISA?

Answer 21

Prudent investing is not judged on the investment results in hindsight but rather by the process employed to investigate and monitor the investment

Question 22

To what extent does ERISA set forth specific guidelines as to the types of investment vehicles and other property that a plan can own or the types of investment transactions in which a plan can engage?

Answer 22

ERISA does not have any specific restrictions or guidelines on the types of investments a plan can hold

Question 23

What are the 3 possible tiers of investment assistance from which fiduciaries can choose?

Answer 23

1. Provision of investment data
2. Investment advice with final decision making authority reserve to the plan’s named fiduciary - this arrangement often called the 3(21) arrangement involves the rendering of investment advice for a few or other compensation
3. Investment management - a so called 3(38) arrangement involves a bank, insurance company, or registered investment advisor that has acknowledged fiduciary status in writing and that has the authority to make investment decisions without further involvement from the named fiduciary

Question 24

Does hiring an investment advisor or investment manager eliminate the fiduciary’s liability?

Answer 24

Hiring an investment advisor or investment manager does not relieve the named fiduciary from understanding the nature of the plan’s investments and chosen investment strategies

Question 25

What is a mutual fund’s liquidity?

Answer 25

Mutual funds issue redeemable shares

Question 26

What government regulations are mutual funds subject to?

Answer 26

Mutual funds are not subject to direct regulation by ERISA but they are subject to regulation under the Investment Company Act of 1940

Question 27

How are mutual funds used as an investment vehicle in ERISA plans in regards to appropriate disclosure documents?

Answer 27

A mutual fund is required to provide appropriate disclosure documents meaning that the fiduciaries of a participant directed plan do not need to design customize fund descriptions for participants