Towards Replacing the Defined Benefit Plan: Assured Retirement Income Provided by a Liquid Investment Fund

Vol. 18, No. 4, 2020

Miguel Palacios, Hayne Leland and Sasha Karimi

Traditional corporate defined benefit (DB) plans provided retirees with constant retirement income, butDB plans have now all but disappeared. While defined contribution (DC) plans now permit low-fee wealth accumulation, the conversion of wealth to predictable nominal or real income during retirement remains opaque and expensive. Complicated, illiquid, and high-fee products dominate the landscape. The goal of acquiring low-fee, predictable future income in retirement, has remained elusive. We describe a relatively simple, liquid, and low-cost series of funds that can address this challenge. The key features are: (1) A minimum assured annual income (real or nominal) for a significant period of time. (2) Maximal exposure at all times to a higher-expected-return risky asset, while meeting the income assurance per share. (3) Liquidity that allows investors’ flexibility to withdraw funds or change assured levels of income at any time, with minimal cost. (4) A simple but significant “behavior nudge” that gives clarity on the future income levels: each share will provide a minimum income of $1 per year for 20 years with the possibility to be extended for lifetime. An investor will know future assured income simply by knowing the number of shares she/he owns. (5) Scalability through reliance on underlying securities backed by the deepest markets in the world. While a strategy to provide the features above is relatively straightforward for a single investor, a deeper challenge is to create a fund that provides these features to all investors, regardless of when shares are purchased. We consider the nature of asset management that achieves all the previous features in a single fund, and believe that it can be done while qualifying for QDIA status.