A New Annuity for 401(k)s
As 401(k) plans and other defined contribution savings vehicles have become more popular in recent years, retirement experts have become increasingly worried about how workers can make these funds literally last a lifetime. Too often, retirees withdraw the money too quickly and end up outliving their savings or, worse, take the whole pot of cash and go off to buy that bass boat they’ve always wanted.
Now, TPC’s Bill Gale, Mark Iwry of The Brookings Institution, David John of the Heritage Foundation, and Lina Walker of the Retirement Security Project have come up with an interesting new solution. Their plan: Turn a chunk of those assets into a voluntary, opt-out annuity which would convert defined contribution assets into lifetime income.
For years, economists have argued for annuitizing at least some retirement assets. Unfortunately, few real people do it. Annuities are complicated and expensive, and, as Irwy says, there are “9 or 10” reasons why people don’t want to buy them.
Annuities are not so necessary now, when typical 401(k) assets are still relatively modest and older workers can look forward to some pension benefits. But as the Baby Boomers and Gen Xers age, 401(k)s will become a retirement cornerstone. Some studies estimate that by 2040, the average 401(k) balance will be in the neighborhood of $450,000. That’s real money and since it, a house, and Social Security benefits will be all most retirees have, it will be crucial that they manage those assets well.
So if annuities are good for us, how can we be enticed into trying them? Gale and friends borrow from recent efforts to encourage 401(k) investing. Not only would workers have contributions automatically withdrawn from their paychecks and invested in balanced lifecycle-type mutual funds, they’d automatically have their assets annuitized at retirement for two years.
Workers could opt-out at retirement or after those 24 months. But the authors expect that few would. Taken together, this structure would look a lot like an old-style DB plan, with two big differences: They’d be portable (a good thing) and all of the pre-retirement risk would be on workers, rather than their employers (maybe not so good). Still, the new scheme is a big improvement over what we have now.
Annuities are no magic bullet. They don’t help with unanticipated needs, such as long-term care, and many low-income workers will never be able to buy an annuity big enough to matter much. But they do make sense as part of a balanced retirement plan. It will be interesting to see if this proposal will encourage employers and workers to dip their toes in the annuity waters.