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Annuities and Your 401(k)


photo_29572_20131112-1A 401(k) plan is a retirement savings plan that is sponsored by an employer.  It allows workers to save and invest a portion of their paycheck before taxes are taken out. While these plans are great for helping employees save and invest, they don’t provide lifetime income benefits, leaving most fearful of outliving their retirement savings. And there’s good reason for such concern. According to a recent Forbes article, fewer than 20% of all 401(k) plans actually help workers convert their assets into paychecks.

One of the only retirement tools available that actually can provide a lifetime income stream is an annuity. These financial products aren’t usually a standard feature of a 401(k) plan. Some believe that the complexity of annuities and the many misconceptions about them is what keeps them underutilized. Another issue is that although workers want lifetime income, employers have not wanted to help them achieve that because of fiduciary liability concerns. This is what led the US Department of the Treasury to recently launch an initiative providing employers new ways to “put the pension back” into private sector contribution plans. The new tax rules allow 401(k) plans, IRAs and 403(b) tax-sheltered annuities for employees of nonprofit employers, to convert retirement accounts into longevity income annuities (LIAs).

LIAs begin making payments to the buyer at a predetermined future age, such as 85, and continues for life. These products are very attractive to some retirees who are concerned about outliving their savings and are looking for a retirement paycheck. For example, a deferred single life annuity purchased at age 65, by a man (woman) costing $50,000, can generate an annual benefit flow from age 85 onward of $24,200 ($19,400) per year for life.

A recent study has actually shown the benefits of including a longevity income annuity in defined contribution plans. After considering normal mortality rates, workers who commit 8-15% of their plan balances at age 65 to LIA, that started to pay them out from age 85, experienced an increase in their well-being, as much as 5-20% of average retirement plan accruals. In general, including longevity annuities as defaults in 401(k) plans and IRAs would make most workers better off, managing retirement risk by “putting the pension back into retirement plans.”

Written by Rachel Summit

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