401k Plans Need A Greater Focus On Lifetime Income

Forbes magazine’s Jeffrey Brown has the right idea in his article “Income As The Outcome: Reframing The 401(k) Plan.”  Company 401k plans were introduced around 35 years ago to help people save more money for retirement.  At that time, many Americans still had pensions that they expected to pay them lifetime income after retirement.  Not enough people really thought about 401k plans as income generators until five or so years ago.  But now that most people don’t have traditional pensions, 401k savings are the largest amount of money that we have to finance our retirement.  401k plans have been labeled “supplemental savings plans” and are often overlooked for their income potential.  Only 20% of plans offer participants an option for guaranteed lifetime income.  Until this changes, we have to take it upon ourselves to transfer our 401k savings into an annuity to generate income.

We don’t save for retirement just so that we can see this massive amount of money we collected during our working years.  At least we shouldn’t.  We save for retirement so that we can stop working and use that money to pay our bills and maintain our lifestyle.  The guaranteed lifetime income from annuities helps ensure that we don’t live too conservatively and miss out on things.  It also ensures that we don’t spend too much and risk running out of money during retirement.  Annuities pool together the money of multiple investors and allow you to receive higher payouts than you would if you simply controlled your own money and withdrawals.  Some people die early and receive fewer payments on their annuities.  This money helps to pay for those people who live beyond life expectancy.  It might sound sad, but this system is a great way to protect against longevity risk and guarantee higher income payments as long as you live.

Although annuities have actually been around for thousands of years, the U.S. government has only recently realized their importance in the country’s retirement system.  401k plan sponsors were terrified of the legality of offering annuities as options in their retirement plans for decades.  The “safest available” provision actually only applies to defined benefit plans, something that the Department of Labor clarified in 2008.  Most 401k plans were built without a guaranteed income annuity option because of fiduciary misunderstandings.  Although the government has been working on spreading information about the importance of annuities in retirement plans over the last few years, it’s not only the plan sponsors who are concerned.  Plan participants have been conditioned to look at their total balance, rather than the income they could receive from their retirement savings.

When annuities are viewed using investment-oriented language, plan participants don’t see their benefits compared to other investments.  But when annuities are viewed as an insurance that will guarantee your income and maintain your lifestyle throughout retirement, participants see their value.  Interesting research found that half of Americans changed their opinion about annuities when the description was changed from investment-based to consumption-based language.  The annuity details did not change, but explaining their benefits in an income mindset allowed plan participants to see just how important these income guarantees are.

The Department of Labor is taking steps to show 401k plan participants the importance of annuities in their retirement planning.  They have proposed legislation that will require plan sponsors to put the amount of income participants could receive from their annuity on monthly statements, right next to the total balance numbers.  The Forbes article suggests more regulation to make it easier for sponsors to offer annuity products and tools to help participants understand the importance of generating lifetime income from their plans.  Income matters more than total account balance.  Guaranteed lifetime income is really what we need to focus on for our retirement.  This is something that government regulators, plan sponsors, and plan participants must realize.  If you don’t have a 401k plan with an employer, you can still save with other vehicles and use those funds to finance an annuity with a lifetime income option.

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