In turning its attention from accumulation to decumulation,
the 401(k) industry created new products to solve income needs, but they came
with significant disadvantages, according to the presenters from Milliman
during a session at Schwab Impact in November.
Ken Mungan, head financial risk management practice, and
Janet McCune, principal and leader of business development, for the Milliman
Southern Employee Benefits Practice, described the strategy Milliman has
developed to help advisors overcome the myriad risks clients face once they
begin taking withdrawals from their retirement accounts.
First, of course, is market risk. Volatility, sequence of
returns and behavior all affect market risk. Volatility forces clients’ hands
when they react to market drops by jumping into cash and missing the rebound.
Mungan said that in addition to losses incurred in the drop, missing that
rebound reduces returns by another 2%.
Inflation risk is another challenge retirees face when they
start drawing down their portfolios. Mungan noted that the oft-touted 4% rule
works when the client has a large allocation to bonds, but by changing the risk
management technique used on the portfolio, an advisor can “dramatically
improve” upon the 4% rule.
Milliman uses managed risk equities to address those
challenges. The 4% rule isn't based on sophisticated models; just the simple
assumption that inflation will be in place forever, “usually around 2%.” He
called that strategy “inflation pre-funding,” claiming a large portion of
clients’ portfolios will go to inflation.
A contingent growth strategy, however, uses managed risk
equities to provide an alternative to inflation mitigation. Higher inflation
typically comes with an increasing stock market over time; those higher equity
returns will offset higher inflation.
Milliman applies a managed risk strategy that uses
volatility management and capital protection techniques. Volatility management acknowledges that when
conditions are right, investors can be a little more aggressive. That strategy
is useful alone, but it's not enough. When everything is going down together,
you need capital protection.
How can that be applied to 401(k) plans? McCune took over to
suggest four ideas for ways advisors could apply managed risk strategies to
plans they advise.
First, they could incorporate managed risk equities into the
fund lineup. In a hypothetical glidepath with reduced bonds and between 50% and
75% risk equities, the Sharpe ratio improved and the sustainable withdrawal
rate increased.
Considering investor appetite for target-date funds, managed
risk “do it for me” portfolios should be a popular alternative. McCune
suggested proprietary collective funds and managed accounts as options.
Keeping retirees in the plan after they stop working is
another way to protect their retirement income, McCune suggested. There are
benefits to the retiree. They’re still invested in a risk-managed plan and they
can get regular payments from the 401(k) plan.
There are benefits to the plan sponsor, too, as the
recordkeeper maintains control over administration. Sponsors still have access
to the participant website and call center, targeted education and
communication, and the recordkeeper manages benefit changes and administrative
matters like change of address.
Finally, clients could purchase deferred income annuities
with plan withdrawals, McCune said.
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