Just convincing many Americans to participate in their 401(k) or other retirement plans is often a struggle. But even after a lifetime of saving, retirees face another problem – making their assets last through a retirement that could be two or three decades – or longer.
Increasingly, workers are retiring with a large pot of cash and no guarantee that the money will last. Some of these retirees had a defined benefit plan, such as a pension, and elected to take it as a lump-sum; others had a 401(k) or other defined contribution plan that did not offer lifetime income options. Without guaranteed lifetime income, even those who retire with large account balances risk running short of money if they live an unexpectedly long life, experience poor investment returns, or have unanticipated health or long-term care expenses.
Making the Money Last
There are tools that can help. Aside from intelligently managing their DC account withdrawals, people can purchase lifetime annuities as they approach or once they reach retirement. These products offer a stream of monthly payments that are guaranteed for life, which transfers the risk of living too long or getting poor investment returns from the individual to an insurance company. Retirees with an employer-sponsored retirement plan or an IRA can use some or all of the balance to purchase a lifetime annuity, but few do so in practice.
Annuity sales to individuals through IRAs have historically been deterred by the complex array of available products and large up-front premiums. Complicating matters are two trends that have made annuities more expensive. First, the low-interest-rate environment has reduced the investment returns that help fund those monthly payments, thus increasing the cost of purchase. Second, there is an adverse selection problem. Because annuity purchasers tend to live longer than the general population, the premiums are set accordingly. The result is that those who have average or below-average life expectancies may find annuities to be a less attractive value.
Group sales of annuity contracts through 401(k) plans can be more economical – but they’re relatively rare. The liability standard for including an annuity in a 401(k) or other employer-sponsored plan is higher than for a mutual fund, and many employers are hesitant to do so.
Lastly, buying a meaningful annuity can require parting with a substantial portion of someone’s accumulated retirement assets. After saving for their whole lives, many retirees are understandably anxious about expending the bulk or all of their savings on one financial product.
So, how can we address this latest retirement challenge? What can plan sponsors and servicers do to help Americans meet their regular income needs in retirement? Should they integrate annuities and other lifetime income features in retirement plans? Should some form of guaranteed lifetime income be the default withdrawal approach for participants, with the ability to opt out?
Similarly, what policy tweaks can government officials make? Should regulators and lawmakers establish new safe harbors for plan sponsors that incorporate lifetime income options? Should there be stronger incentives for employers to do so?
The answers are far from clear, but a lifetime’s worth of income may depend on it.
Join us at BPC on Wednesday, April 1, as we discuss the challenge of lifetime income in defined contribution plans. We will be joined by John Haley, the CEO of Towers Watson, and an expert panel to discuss how public policy can improve the chances that Americans will be able to find secure lifetime income that enables them to maintain their financial independence through retirement.
Alex Gold contributed to this post.