401(k) Annuities: An Idea Whose Time Has Come?

With traditional pension plans fading away and housing values still falling, many Americans worry that their retirement nest egg won’t carry them through decades of retirement.

Heeding those concerns, a small but growing number of companies are enhancing their employees’ defined contribution plans by offering deferred annuities that provide a guaranteed income stream in retirement.

Options vary, but generally, a worker can convert part or all of a 401(k) into an annuity that pays a fixed amount for life, regardless of how stock market swings affect the account balance.

Debate about how to shore up retirement security in the United States has heated up since workers suffered huge losses in their 401(k) accounts during the recession. Some people on the verge of retirement have been forced to stay on the job longer because of shrinking portfolios.

As the gap widens between what Americans have saved and what they’re likely to need in retirement, the Obama administration’s Middle Class Task Force is looking into encouraging or requiring employers to offer annuities or other income-generating options in their 401(k) plans.

In February, the Labor and Treasury departments sought comments from the public and industry experts on how to best integrate such options into employees’ retirement plans—and how to protect future retirees enrolled in them. Among the questions that the government asked:

* Should some form of lifetime income distribution option be required for defined contribution plans?

* If so, should that option be the default distribution option, and should it apply to the entire account balance?

Roadblocks ahead

The issue clearly hit a nerve. By June, officials logged nearly 800 comments from individuals, companies, advocacy groups including AARP, and others. Some angrily opposed any government mandate for employer-sponsored 401(k) plans, while others welcomed the steady income stream in retirement that annuities provide.

“I think having some form of annuitization available to plan participants would be nice and would make sense for some, some of the time,” said one 401(k) plan sponsor. “However, and I want to make this very clear—any annuitization option should not be mandatory.”

Another man wrote, “Fund your massive deficits through some other ruse and keep your hands off my 401(k).”

Offering annuities or similar investment products as part of employees’ 401(k) accounts began with a few employers, including IBM and Smithfield Foods, several years ago. But financial experts say the idea has been slow to catch on, partly because of unresolved issues such as lack of portability, higher fees and protections for investors.

Typically, a worker who changes jobs can roll a 401(k) account into an IRA or into a new employer’s 401(k) plan. However, if the old 401(k) plan is an annuity or is partially annuitized, a worker could only move it if the new employer’s plan offers the same annuity option.

The worker could keep the annuity in the former employer’s plan, but wouldn’t be allowed to contribute more money to it. If the worker wanted to roll the annuity into an IRA, he may have to cash it out first, possibly losing the guaranteed income option—and the fees paid for that option.

“Everyone thinks it’s a great idea in theory. It’s how we implement it that’s the challenge,” says Robyn Credico, senior consultant at Towers Watson, which specializes in employee benefits. “The roadblocks would need to be overcome.”

Another obstacle involves the fiduciary responsibility of employers that could be held liable by plan participants if the financial services firm or insurance company that provides the annuities goes belly-up. Remember Lehman Brothers’ sudden demise and AIG’s fight for survival in 2008?

“If the government could make employers feel more protected, you’d see a huge movement with companies offering lifetime incomes in retirement,” Credico says. “Until that happens, this will be a huge challenge."