CRITs: An Alternative Retirement Income Approach
By Mark Shemtob
Retirement Section News, September 2021
There is little doubt that for the foreseeable future 401(k) plans will continue to be the primary private sector employer provided retirement program. Unfortunately, 401(k) plans are not designed to provide retirees with the steady lifetime retirement income needed. Many plan participants could benefit from assistance in converting their retirement savings into reliable retirement income. Though employer plans can fulfill this role, to date there is little evidence that employer 401k plans regularly offer lifetime income distribution options, thus requiring many plan participants to assume this challenge on their own. In addition, most retirees do not have all their retirement savings with their current employers but instead have retirement accounts scattered about with prior employers or in Individual Retirement Accounts (IRAs).
Retirees can use their retirement savings to purchase a guaranteed lifetime income annuity from an insurance company. However, these annuities tend to be unattractive. One primary reason is the perceived high cost of these annuities relative to the benefits being provided. This is especially true in a low interest rate environment. An alternative approach is for retirees to manage their retirement income through pre-planned structured withdrawals from an investment portfolio. However, this approach requires some investment knowledge, may not provide sustainable lifetime income, and does not take advantage of longevity risk pooling, which enhances retirement income security. By using longevity risk pooling, larger benefits can be paid through the forfeiture and redistribution of funds from those who have died and no longer need the income. Other insurance company products guarantee minimum income levels but come with a concern that fees are high as well as other limitations. These products do not incorporate longevity risk pooling features.
So, are there other approaches that might be explored? The answer may lie in what we will refer to as “Collective Retirement Income Trusts” (CRITs). CRITs would be established, administered, and managed by financial institutions and would be open to all individuals with retirement savings. CRITs would not be offered or administered through employer-sponsored retirement plans, although they theoretically could if those plans were large enough. Providing access to CRITs directly to individuals eliminates the need to have employers offer retirement income options, which is a large challenge for smaller retirement plans and one that larger employers remain reluctant to provide.
When a retiree plans to start drawing on their retirement savings he or she would be allowed to transfer some or all of their retirement savings (from employer plans or IRAs) into a CRIT. The CRIT would then directly pay the retiree a monthly annuity income. The retiree would select the form of the annuity, which would include “life only,” “life with a term certain,” “joint and survivorship,” and possibly other forms of annuity. Individuals who are concerned with the prospect of an early death would likely not select the “life only” option.
The CRIT would invest in a collective professionally managed balanced portfolio similar to how an ongoing defined benefit plan assets might be invested. The initial monthly benefit amount the retiree would be entitled to would be calculated based upon the amount of their retirement savings that had been transferred to the CRIT, the ages of the retiree and co-annuitant (if applicable), an assumed investment rate of return based on the portfolio composition, assumed life expectancies for the covered group (likely on a sex distinct basis), and the annuity option selected.
Unlike traditional defined benefit plans and insured fixed income annuity contracts, the CRIT benefit payment is not a fixed amount. It is a variable amount subject to periodic (likely annual) changes, which could increase or decrease. These possible changes reflect the actual investment performance of the CRIT compared to the rate of return assumed on the portfolio, and the actual lifespan experience of the retirees compared to what was assumed. Additional changes to benefit levels might occur if it seems appropriate (by the CRIT sponsor subject to regulatory requirements) to adjust the future investment return or life expectancy assumption. Such assumption changes would be appropriate to reflect changes in the investment environment and future anticipated life expectancy of the covered group.
In order to prevent large swings in benefit amounts (either up or down), benefit adjustments may not immediately reflect the full changes but would instead be spread over several years. Note that the use of more conservative investment and life expectancy assumptions would have the impact of providing smaller initial benefit levels but with a greater likelihood of future benefit increases. It may also be possible to have a CRIT provider offer alternative options with different underlying investment portfolios. Those retirees who are concerned with too much volatility would probably select a more conservative option and those retirees willing to take on the risk that is accompanied by a larger potential benefit amount would probably select a less conservative option.
There is a potential for significantly larger benefits from this approach compared to insured annuity purchases through traditional fixed income annuity contracts. The potentially larger benefit results from higher expected investment returns from the CRIT and lower operating expenses, including elimination of sales compensation costs, insurance company profits, investment guarantee margins, and mortality guarantee margins. Based on studies done in Canada where variable benefit type programs are now being offered, it is estimated that benefits up to 25 percent larger might be provided by this arrangement over the purchase of insured fixed income annuities.
CRITs would be regulated by federal government agencies (Treasury and Labor) to protect the interests of the retirees. Among the issues that regulators will need to monitor include, but are not limited to, the overall CRIT operating expenses, the investments being used, the investment return and life expectancy assumptions used to calculate benefit levels, and the methodology used to periodically adjust benefit levels. Annual independent audits of the CRITs may be desirable.
Some may feel that CRITs would make it difficult for insurance companies to compete with their fixed income annuity products. Those that want guaranteed income would still use those products. The CRIT simply offers another alternative. In addition, insurers would likely be among the larger providers of CRITs. They would profit from administering CRITs and would have no financial risk to reserve funds, since all the risk would lie with the retirees through benefit adjustments. Others may argue that there is a risk that benefit levels may decrease from the initial levels. However, this is also the case with individuals that manage their retirement income through investment portfolios.
CRITs would be valuable for individuals who are seeking predictable lifetime income, are not comfortable managing their retirement funds in the payout stage, do not have access to unbiased outside expertise, and who do not participate in an employer plan that offers retirement income options. Retirees would, of course, retain the option to not participate in a CRIT. Currently this type of variable benefit arrangement is not permitted in the United States. Legislation would be required by Congress to allow them. Note that retirement programs using collective variable income benefit approaches are already being used in the Netherlands, Great Britain, Canada, and elsewhere.
Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries, the newsletter editors, or the respective authors’ employers.
Mark Shemtob, FSA, CFP®, EA, FCA, MAAA, MSPA, is owner of MS Advisory LLC. He can be contacted at email@example.com.