I recently attended a conference in Washington on the question of retirement income—how baby boomers will generate income from their 401(k) accounts once they retire.
The issue is this: Current workers are more likely to have 401(k)s (or similar accounts) for retirement than monthly pensions. 401(k) accounts pay out a lump sum benefit, which most workers roll over into an IRA at a bank, brokerage firm, or mutual fund company. So, without any monthly pension check, how will future retirees create a regular income stream from their nest egg? The question is so important that the government recently issued a public “request for information” for answers.
Why is the government interested? Put on your public policy hat for a moment. The federal government provides tax incentives to 401(k) accounts to encourage retirement savings. Washington is worried that some (many?) aging retirees might mismanage their savings and run out of money altogether. That would lead to higher old-age poverty—a social problem in and of itself—along with demands from impoverished seniors for more governmental assistance.
Much of the discussion at the forum focused on ways to encourage Americans to purchase more guaranteed annuity income with their 401(k)s. By buying an immediate income annuity, you have the option to hand over a chunk of your capital to a private insurer, who promises to pay you (and/or a survivor) a guaranteed income for life, no matter how long you (or the survivor) live. Annuity contracts solve a central problem for the government: They minimize the risk of older retirees running out of money. And they’re helpful if you are looking for guaranteed income on top of Social Security.
The problem is that Americans by and large are uninterested in purchasing income annuities. (Investors buy lots of variable and fixed deferred annuities, but as investment and tax-deferral vehicles, not as sources of income.) With the traditional annuity, you lose permanent control of your assets in exchange for the guaranteed income stream. And you run the risk that the private insurer might fail to pay (though failures have been rare). According to recent insurance industry statistics by LIMRA, Americans have only bought about $15 billion of income annuities in recent years—versus hundreds of billions of dollars rolling out of retirement plans each year.
So, on the one hand we have the retirement experts, who are looking to promote annuities, and on the other hand there is the broader public, largely uninterested in them. Supporting the experts’ point of view is longevity risk—none of us knows how long we will live. Even if you plan your finances through age 95, you might be the one person in your family to live to age 100. Supporting the broader public view is the idea that most everyone has Social Security as a backstop, albeit a modest one. Combine that with the fact that only a small percentage of Americans will ever make it to their late 90s, and the argument for annuity income is hard to make.
For the moment, one thing is true: The attention on this issue by government and industry is likely to grow. Investment companies and advisors are working on educating clients about techniques to spend down savings sensibly (without resorting to annuities), while providing non-guaranteed income streams from various types of portfolio or fund investments. Insurers are promoting the traditional annuity, while creating new types of hybrid annuities that combine portfolio elements with insured income. The marketplace is generating many new ideas.
It will probably be a year before the government formulates any specific plans around retirement income. My guess, though, is that even if policymakers decide to tilt the scales, even if only slightly, toward annuity contracts, it will have little impact.
The fact is, for most of us, “retirement security” is more than having a guaranteed monthly check. It is also having a pool of savings as a form of financial security—to be used in a flexible way as our life evolves in retirement. If that is true, many Americans with 401(k) savings may have only limited interest in guaranteed income streams on top of Social Security. Check back in a decade, and we’ll see.
• Product guarantees are subject to the claims-paying ability of the issuing insurance company.
• Variable annuities are long-term vehicles designed for retirement purposes and contain underlying investment portfolios that are subject to investment risk, including possible loss of principal.