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?
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."
A chance for ‘peace of mind’
Brent Walder, a senior vice president at Prudential Retirement, which administers defined contribution plans with lifetime guaranteed income options for 187 employers, says this relatively new approach to retirement plans is what boomers and other workers want for their “peace of mind.”
He says Prudential’s lifetime guaranteed income options are linked to target-date funds—investments that automatically become more conservative over time as plan holders approach retirement. The fees are slightly higher than those of other retirement options. The cost for the investment management is between 0.5 and 0.75 percent, and the cost for the guaranteed income option, which doesn't kick in until 10 years before the fund's target retirement date, is an additional 1 percent.
The appeal is that the annual income is guaranteed. “Let’s say you have a $100,000 balance and you [get] $5,000 a year for as long as you live,” Walder says. “That $100,000 is still invested and could grow or drop depending on the market. If your portfolio balance goes up, you get a higher income stream. If the market doesn’t do well and your balance goes to zero, you’re still guaranteed that $5,000 a year.”
With people living longer today, low-cost options to annuitize 401(k) accounts “should be readily available and promoted to ensure an income stream throughout retirement,” says Dave Certner, AARP’s legal policy director.
But he adds that annuities may not be the right choice for every retiree, particularly those who have smaller 401(k) account balances or who already have a large amount of annuitized income like pensions. He also says workers and employers must be wary of excessive fees.
For Ron Baker, 70, investing his entire 401(k) balance into an annuity was the “best decision I ever made.” He retired two years ago as a sales representative for an insulation manufacturer in Louisiana.
“Everything has been exactly as represented,” he says. “Even though the value of my portfolio dropped with the market in 2008, I was still paid on the amount I rolled over” into an annuity.
“The nice part is that it’s guaranteed for life. If I invested it someplace else and I wasn’t protected, I’d get less on a lesser amount,” he adds. “Between this income and Social Security, my lifestyle hasn’t changed whatsoever.”
Carole Fleck is a senior editor at the AARP Bulletin.