Forbes Magazine’s Ashlea Eberling recently asked the question “Should Employers Default Workers 401(k)s Into Annuities?” It’s a difficult topic to approach because people are not usually receptive to being told what to do or being forced to put their money somewhere. But many people have mentioned the idea of defaulting some of workers’ 401k savings into an annuity that would provide them with lifetime income upon retirement. Workers could of course opt out of this default, but would they want to if they understood the benefits? One guest scholar at the Brookings Institution said that the word annuity is considered “poison”, not for what the product actually does, but for what people perceive it as. A recent lifetime income conference purposefully omitted the term annuity from its name: “Making Your 401(k) Last: The Challenge of Lifetime Income in Defined Contribution Retirement Plans.” They certainly didn’t omit talk about the importance of using annuities to create this lifetime income from the actual conference though.
Annuities are important because they are one of the only ways to create lifetime income payments from your retirement savings. Only four decades ago, most companies offered pensions that would pay their employees lifetime income at retirement. But 2/3 fewer Fortune 500 companies offer pensions than they did in 1998. And most of those that do are trying to get out of their lifetime income promises by offering lump sum payouts. This brings about a large need for workers to create their own income in retirement. With the disappearance of pension plans came a sharp increase in the use of 401k plan savings. But 401k plans were originally introduced as a supplemental savings plan to pensions. That is why 401k’s don’t innately include a lifetime income stream. Right now, only 12% of 401k plans offer lifetime income options. Only 5% of the employees in those 401k plans actually opt for the annuity payout. It’s time for more 401k plans to offer lifetime income annuity options and maybe even use them as the default payout. It’s also time for better annuity education for the general public so they can see the benefits of creating a guaranteed lifetime income stream from their 401k savings.
One of the most important things to remember when it comes to annuity products is that they are not all or nothing. It’s wise to determine your necessary expenses in retirement and purchase an annuity to cover those basic expenses, or what is still needed to pay those bills after taking Social Security payments into account. It’s also important to account for longevity risk. Sometimes using a combination of an immediate annuity and a longevity annuity works in financial plans. There is a real risk that Americans could run out of money as they live a long time in retirement. Deferred income annuities start paying you money far into the future and ensure that your payments continue no matter how long you live. Just like traditional annuities, Social Security is an annuity product that pays you higher income payments the longer you wait to start receiving your money. You can delay Social Security until age 70 by purchasing an annuity that covers your income payments from retirement until age 70, however long that might be for you.
The government has made it easier to use annuities in 401k plans and within target-date funds over the past year or so. Making annuities the default option in 401k plans would be taking these regulations a step farther, but could really help secure income for many Americans. The idea of a minimum annuitization standard has also been recommended by some experts. While that idea does make sense in some circles, it’s recent repeal in the UK makes it unlikely to be popular on this side of the pond. Many employers now provide lifetime income disclosures on their 401k statements. This allows people to see exactly how much income they would receive from their current 401k balance. You can ask your employer for this type of statement if you don’t already receive it from your 401k. It’s not easy to create an income stream, even if you have saved up a hefty amount of money in your 401k plan. Americans could really benefit from their 401k plans offering annuities as a payout option, but many need more education to wrap their heads around that option. Unfortunately for plan sponsors, they need a better safe harbor to protect them from fiduciary liabilities. There are some valid arguments to be made for defaulting some of workers’ 401k savings into annuity products, but it will take some work from the industry to get more Americans and plan sponsors on board with the idea.