Painting a Fuller Picture: A Framework for Comparing Lifetime Income Solutions

April 05, 2024

3 min read

Andrew Stumacher| Managing Director—Custom Defined Contribution Solutions

Christopher Nikolich| Head of Glide Path Strategies (US)—Multi-Asset Solutions

Howard Li, CFA| Senior Research Analyst—Multi-Asset Solutions

It can be a tall task to compare diverse lifetime income solutions. Applying a comprehensive framework may enable a level playing field.

The distinctions among lifetime income solutions are wide-ranging—from cash-flow patterns to investment exposures, and from explicit fees to hidden implicit costs. The differences are multi-faceted, which may make them hard to quantify using common frameworks for analyzing investment solutions. In our view, using traditional metrics risks painting an incomplete picture of lifetime income solutions.

This partial picture could lead defined contribution (DC) plan sponsors to reach a less-than-optimal decision when selecting a lifetime income solution to meet their plan’s needs. We think there’s a better, more complete way to stack different approaches up against each other, which is vital when making such a critical decision.

Developing a Comprehensive Framework

A holistic framework may paint a fuller picture, enabling DC plan sponsors to better compare lifetime income solutions (Display). It should consider all key factors that could impact participant outcomes. And—as with any sound framework—we think it should be rooted in core principles:

Focus on the individual—not the average. Everyone’s retirement time horizon is unknown, but finite. Not every participant lives to the average life expectancy of 87 years or experiences the average market return during their lifetimes. Incorporating some type of income insurance may reduce this risk, but it’s important to analyze retirement outcomes over a variety of time horizons and market outcomes to represent what different participants might actually experience.
Take a broad look at all key participant risks. All forms of lifetime income insurance are designed to eliminate longevity risk—outliving retirement savings. But some types require surrendering assets to an insurer up front in exchange for that income. This may create another risk: mortality. A person might die before the average life expectancy, failing to fully recoup income benefits from forfeited assets. Insurance riders that address mortality risk may be costly in terms of reduced income.
Most income insurance may also help tackle the short-term risk of equity market losses that could make income streams less sustainable. But some insurance types, such as fixed annuities, require reducing equity exposure too much, in our view, which could hurt long-term growth potential. Inflation may exacerbate this issue by further eroding spending power.
Evaluate more aspects than income. Plan participants understandably want income from their lifetime income solution, but that’s not the only thing they value. Based on our surveys, nearly two-thirds of participants also want the ability to access their assets to handle unplanned expenses or leave a legacy if they have an account balance left at the end of their lives. The specific preferences may vary by participant, but these twin needs call for considering liquidity and access to assets.
Measure total insurance cost. From a participant’s perspective, the total cost of a lifetime income solution includes both explicit and implicit costs. On the explicit side, there are stated annual insurance premiums, charges and commissions, as well as management and administrative fees. Fixed annuity–based solutions also carry implicit costs under the surface, which stem from mortality risk and growth opportunity cost. With growth opportunity cost, consider a hypothetical participant who surrenders assets to an insurer up front. If the market rallies, the participant no longer has the assets to take part in that growth. It’s a missed opportunity that can be viewed as a cost. And for participants, all costs matter.

Evaluating Income Solutions for Individuals

Key Issues Impacting Individual Participants Must Be Addressed

A table showing key issues and considerations required in assessing lifetime-income solutions.

Factors in bold are crucial factors that may often be overlooked in the evaluation of DC income solutions.
As of March 31, 2024
Source: AllianceBernstein (AB)

Depending on the specific design of insurance solutions, the implicit costs may be sizable, which could make total cost quite a bit higher than explicit fees alone. In order to convert implicit costs into measurable ones, we believe that an evaluation must consider the potential range of outcomes an individual may face. That requires projecting a range of potential lifespans and market experiences.

Looking at the Big Picture

It’s well-known that lifetime income is high on DC plan participants’ wish lists, and that they need help securing it. Thankfully, a broad array of solutions are available to help them secure that income. However, solutions don’t all come from the same mold—whether it’s different cash-flow patterns, investment exposures or other aspects.

To select the solution that makes the most sense for a specific plan, we feel that comparing them on a level playing field is important. Because the differences are multi-faceted, we believe a comprehensive framework is needed—one that focuses on the individual, looks at all key participant risks, evaluates needs beyond income and measures total insurance cost. As we see it, such a framework can be a powerful tool.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.

About the Authors

Andrew Stumacher

Andrew Stumacher is a Senior Vice President and Managing Director for AB’s Customized Defined Contribution Solutions. He is responsible for developing, implementing and driving the growth of custom target-date, model portfolio and retirement income strategies for the large and mega-size institutional plan market, in which AB serves as one of the largest managers in the US. Stumacher works in close collaboration with plan sponsors, consultants and external business partners to develop innovative and flexible products to improve outcomes for DC plans and participants. He joined the firm in 2004 as a marketing analyst, focusing on strategy and development for new institutional products. From 2011 to 2017, Stumacher managed the integration of AB’s DC products with recordkeepers, trustees, custodians, insurers and investment managers as the DC partner relationship officer. He holds a BS in applied economics and management from Cornell University and an MBA from Wagner College as well as the Certified Annuity Specialist™ designation from the Institute of Business & Finance. Location: New York

Christopher Nikolich

Christopher Nikolich joined AB in 1994 and is the Head of Glide Path Strategies (US) in the Multi-Asset Solutions business, leading research efforts relating to effective target-date and lifetime income fund construction. He is an author of defined contribution–related research, such as Designing the Future of Target-Date Funds: A New Blueprint for Improving Retirement Outcomes and Leveling the Retirement Income Playing Field: A Comprehensive Framework for Evaluating Diverse Lifetime Income Solutions. In addition, Nikolich has authored thought leadership focused on a variety of topics, such as plan design, asset allocation and inflation. He works closely with clients in the structuring of their customized target-date and lifetime income funds. From 2002 to 2008, Nikolich worked in both New York and London as a senior portfolio manager on the Blend Strategies team, collaborating with clients on the creation and implementation of multi-asset class solutions. From 1996 to 2002, he was a portfolio manager in the Index Strategies Group, where he managed risk-controlled equity services. Nikolich holds a BA in finance from Rider University, an MBA in finance from New York University. He is a member of the Board of Trustees of Rider University, the Vice Chair of Rider University’s Investment Subcommittee and is a former member of the Executive Committee of the Defined Contribution Institutional Investment Association (DCIIA). Location: New York

Howard Li, CFA

Howard Li is a Vice President and Senior Research Analyst for AB’s Multi-Asset Solutions division. He works in the US Defined Contribution Research and Investment Management team, where he is responsible for custom glide path construction, asset allocation and portfolio management of target-date solutions for US defined contribution (DC) plans. Li works with plan sponsors to develop custom glide path strategies that are tailored to DC plan sponsors’ objectives and participants’ demographics. He joined the firm in 2006 as a quantitative research analyst. Since 2008, Li has focused his research on asset allocation and investment management of custom target-date and lifetime income strategies. He holds an MSc in computer science from Boston University and an MBA in finance and economics from Columbia Business School. Li is a CFA charterholder. Location: New York

Painting a Fuller Picture: A Framework for Comparing Lifetime Income Solutions

Developing a Comprehensive Framework

Looking at the Big Picture

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