Working to find actionable solutions to the nation's key challenges.

Legislation Could Reduce Risk of Retirees Outliving Savings

By Ben Ritz

Thursday, October 27, 2016

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This is the second post in our series about promising proposals to advance retirement security in America. 

It’s no secret that Americans are living longer. Since the 1940s, the average life expectancy for an individual at age 65 has increased by more than six years. Yet, the average retirement age has remained relatively stagnant, meaning that retirees must make their savings last longer. This is particularly challenging given the changing landscape of employer-sponsored retirement plans.

Many companies used to offer defined benefit (DB) pensions, which must provide an option to receive benefits in the form of guaranteed monthly income for the lives of the participant and a surviving spouse. But most private-sector employers have now transitioned to defined contribution (DC) plans, such as 401(k) plans, wherein workers accumulate savings for retirement. DC plans are not required to incorporate lifetime-income distribution options (most do not), so the vast majority of 401(k) plan participants and their beneficiaries are on their own to make those savings last throughout the remainder of their lives.

Americans are living longer, but the average retirement age has remained relatively stagnant.

These trends have increased the risk of American retirees outliving their savings—known as longevity risk. According to the Employee Benefit Research Institute, more than two-thirds of the longest-living Gen-Xers (those individuals born between 1965 and 1974) are projected to run short of money during retirement. To address this challenge, BPC’s Commission on Retirement Security and Personal Savings offered nine recommendations to facilitate lifetime-income options, such as annuities and automated withdrawal programs.

The Retirement Enhancement and Savings Act of 2016 (RESA), which was approved by the Senate Finance Committee just last month, includes three provisions that would promote the inclusion of lifetime-income features in DC plans:

Lifetime-income disclosure: Quarterly 401(k)-plan account statements show the amount a participant has saved, but most statements do not offer an illustration of how much monthly income these savings could generate in retirement. Based on provisions in the Lifetime Income Disclosure Act (S. 1317) introduced by Senators Johnny Isakson (R-GA) and Chris Murphy (D-CT), the RESA would require DC plans to include a lifetime-income disclosure in at least one account statement during each 12-month period. The disclosure would include two projections of the lifetime-income stream that could be supported by the account balance: one for a joint-and-survivor annuity that would generate monthly income for the lives of both the participant and a surviving spouse, and another for a single-life annuity that would not offer any benefits for a surviving spouse. The provision would also shield plan sponsors from legal liability should actual retirement income from the plan be lower than the amounts projected, a concern that has discouraged employers from offering lifetime-income projections in the past.

Lifetime-income portability: Under current law, plan participants who select a lifetime-income option that is later discontinued by the plan sponsor can experience adverse consequences, such as “surrender fees” if an annuity contract is cancelled, or taxes and early distribution penalties if the lifetime-income product is distributed from the plan. Fear of this situation also discourages employers from offering any lifetime-income options within DC plans. A provision of the RESA—one supported by both the Obama administration and Senate Finance Committee Chairman Orrin Hatch (R-UT)—would address this portability issue by allowing participants who have selected lifetime-income options that are discontinued by the plan to elect an in-service distribution of the annuity or other lifetime-income product to an Individual Retirement Arrangement or another employer-sponsored DC plan that does support the product. Such flexibility would help participants avoid premature taxes and unwanted early termination fees.

Carrier-selection safe harbor: Under current law, plan sponsors are required to discharge many responsibilities when selecting lifetime-income features, such as annuities, for inclusion in the plan. In addition to conducting a thorough, analytical search that includes evaluating the benefits, costs, and features of an insurance product, plan sponsors must conclude that the insurance company is financially strong enough to meet its obligations under the contract. While there is widespread agreement that plan sponsors are capable of and should be expected to assess the features and costs of an annuity contract and make a prudent decision for their participants, the issue of evaluating the financial strength of the carrier has generated controversy and served as a barrier to adoption of lifetime-income options.

The vast majority of 401(k) plan participants are on their own to make savings last throughout retirement. 

To resolve this issue, the RESA includes a provision that shields employers from liabilities related to the solvency of the insurance carrier if the employer obtains written assurance from the insurer that the insurer is in compliance with various insurance regulations and in good standing with state insurance commissioners where the employer conducts business. Plan sponsors that use this new process to evaluate the financial strength of carriers would still be legally responsible for conducting their own evaluation of the product features, benefits, and costs of any annuity contract and acting in the sole interest of participants when selecting insurance products for inclusion in the plan.

Although some details differ, each of these provisions parallels a recommendation by BPC’s commission. They represent several positive steps forward upon which policymakers can build to better facilitate lifetime-income options and reduce the risk of retirees outliving their savings.