What Makes a GIC Tick? Time to Look “Under the Hood”
Guaranteed Insurance Contracts, or GICs, are marketed as a reliable - even simple - company retirement plan investment vehicle. In my experience, however, employers whose 401(k) or 403(b) plans include GICs and their participants could benefit from carefully examining the GICs inner workings as they consider the best option to build toward a secure retirement.
My initial sit-down with employers who include a GIC in their company retirement plan offers a good occasion to “pop the hood” of their plan. Frequently I hear that their employees like the GIC because it “guarantees” a rate of return, they are protected from potentially negative investment returns, and – in most cases – there are no “fees” associated with their selection of the GIC. So, I find it helpful to examine with them some of the gears and levers that make a Guaranteed Insurance Contract tick.
The truth of the matter is that a GIC is not the best way to meet most employees’ long-term retirement needs. Although a GIC does guarantee a rate of return, the return is not high enough to meaningfully outpace inflation and taxes. Loss of purchasing power due to inflation is arguably the most dangerous risk a long-term investor can face. Therefore, the employee should seek a real return above inflation. GICs are not designed to provide a real return so it’s the rare employee who can prudently invest their entire retirement account balance in a GIC.
And as far as fees go, GICs can be an enormous profit center for insurance companies. The reality is that significant earnings are associated with a Guaranteed Insurance Contract, but they do not make it into the pockets of the retirement plan participants who are invested in them. In a traditional GIC, the insurance company takes the money from the participant and invests it. While the insurance company may promise a minimum rate of return, that rate is usually significantly lower than the returns the investment company is earning from its investment.
Plan sponsors and participants alike need also be aware that another “profit center” for the GICs is the insurance company representative advisors who have touted them. Those representatives have often received commissions and other incentives to have GICs included in the retirement plan line-up and selected by plan participants. So, where most employees would benefit from investing most of their retirement account balance in equities and longer term fixed income investments and only a very small amount in a GIC, the insurance company and agent benefit financially when the employee does the opposite, investing a meaningful percentage of their retirement account in a GIC.
So, what is a plan sponsor to do? Plan sponsors want to make sure they offer the best investment alternatives possible for their employees and carefully select an advisor that will provide the kind of investment education that is in the participants’ best interests, that will encourage them to be prudently invested to meet their retirement goals.
In a previous bog I’ve discussed how Managed Accounts offer participants an optimum investment option. A Managed Account allows participants to benefit from professional investment management of their savings in a way that matches their unique situation, considering such characteristics as their total assets, their risk tolerance and their anticipated longevity. Managed Accounts increasingly are available in the small plan market, and plan sponsors should look for a provider that offers them without additional fees. (Less optimum because it takes a one-size-fits-all approach, although still preferred to total reliance on a GIC because it offers a diversified investment strategy, is a Target Date Fund series.) In another blog post, I’ve shared how participants can “miss the mark” in selecting the best fund in a Target Date series.
You are at the wheel when it comes to the investments in your corporate retirement plan and the service providers who offer education and guidance to your employees. Make sure you and your plan’s participants fully understand the nature of a guaranteed income product. And contact me if I can be helpful to you in “popping the hood” on your plan and its investments.
This blog is written to help make the lives of plan sponsors easier in the process of meeting legal requirements under ERISA for their defined contribution plans. Please understand that reading this blog should not alone take the place of a one-on-one consultation regarding the needs of your specific plan, and hence cannot be a guarantee against fiduciary breaches.