Why don’t more retirees convert at least some of their nest egg to lifetime income? It’s a question that vexes financial planners and has policymakers scrambling for solutions.
For many years, traditional defined-benefit pensions provided millions of people with an income stream they could not outlive. Along with Social Security benefits, this pension income covered all the basics and possibly then some, for as long as you lived. Personal savings was gravy.
Such pensions largely have been replaced with defined-contribution plans like the 401(k), which may provide a sizable kitty at retirement. But now it’s up to the retiree to decide how to make that money last for 20 or 30 years. Most people aren’t very good at it, and their eroded Social Security benefits don’t offer much of a backstop.
So the focus of retirement planning has shifted in recent years. How can retirees get the kind of lifetime income that traditional pensions once provided? The answer doesn’t seem so complicated. All you have to do is take a portion of your 401(k) and purchase an annuity, which is an insurance contract that agrees to pay a monthly benefit for life or some other specified period.
Yet “annuitization” is not happening on a large scale. There are many reasons. As Nevin Adams of the Employee Benefit Research Institute writes in his blog:
“A number of explanations have been put forth to try and explain this reluctance: the fear of losing control of finances; a desire to leave something to heirs; discomfort with entrusting so much to a single insurer; concern about fees; the difficulty of understanding a complex financial product; or simple risk aversion—all have been studied, acknowledged, and, in many cases, addressed, both in education and in product design, with little impact on take-up rates.”
As Adams suggests, annuities have been made simpler and their fees have been cut. Some have been reshaped to include survivor benefits. Schwab just introduced an easy-to-understand low-cost retirement income variable annuity that, for a price, guarantees a minimum level of income for life.
Nothing seems to help. So plan sponsors and administrators and policymakers are exploring turnkey ways for retirees to convert assets in their 401(k). Making annuitization easier would certainly help. But the surest solution—and one that is likely to gain traction—may involve plan sponsors putting up some blocks to the oh-so-popular lump-sum distribution.
Workers with no plan restrictions on lump-sum distributions cash out all assets way more often than workers with some restrictions, EBRI reports in a January brief. The firm looked at plan participants aged 50 to 75 who made a payout decision from 2005-1010 and had more than $5,000 in the plan. Those with no plan restrictions had an annuitization rate of just 27.3%, vs. 65.8% for those in a plan with restrictions on lump-sum distributions.
That’s a big difference. With lifetime income having emerged as a central focus of retirement planning, look for your employer to erect some barriers. Already, we’ve seen how features like automatic enrollment and auto-escalation of contributions has raised the retirement security of millions of workers. Increasingly, it seems that plan design is seen as the antidote to poor plan participant decisions.