In just a shade over three decades, the 401(k) plan has gone from a nice little fringe benefit for executives to the nation’s dominant form of retirement savings plan. But whether it will really put gold into the golden years, as its advocates suggest, or instead leave millions of elderly Americans with little or no income beyond Social Security is a question that remains unanswered.
It is clear, though, that the once-familiar "three-legged stool" of retirement security — Social Security, a traditional pension and personal savings — has been undermined by the 401(k) plan. Since traditional pensions have gone the way of the gold watch at retirement, millions of workers now will have only two "legs" to retire on, and shaky ones at that — Social Security and personal savings, largely through 401(k) plans. With Social Security replacing only about a third to a half of pre-retirement income, retirees who exhaust their savings before they die face a greatly reduced standard of living in their final years.
It’s obvious, of course, that much depends both on how much employees invest during their working years, whether they invest wisely, and how well the markets do overall. Economists have been studying whether workers are investing enough, and their conclusions vary widely. Some experts are alarmed at what they find; others say most workers are doing pretty well.
Less attention, though, has been paid to what happens after a worker retires and begins drawing upon his or her accumulated balance. Since new retirees are unlikely to know how long they will live or what kind of return they will get on their money, it’s impossible for all but the wealthiest to know for sure how much they can withdraw each month or each year without running out of money.
Passages: From Wealth Accumulation to "Decumulation"
Now, with the first of the baby boom generation due to turn 65 next year, economists, planners and policymakers are turning their attention to what has been dubbed the decumulation phase of 401(k) retirement financing.
Recently, the Treasury and Labor departments put out a joint "request for information" on what, if any, steps the government might take to help future retirees turn the funds they have accumulated while working into streams of income that will last the rest of their lives. Think of them as annuities or personal pensions. Agency officials are concerned that retirees have neither the experience nor expertise to manage their retirement savings well, and are looking for ways to cope with this fundamental flaw in a 401(k)-based retirement system.
A driving force behind the request has been J. Mark Iwry, deputy assistant Treasury secretary for retirement and health policy, senior adviser to the Treasury secretary and one of the high priests of a regulatory reform movement dubbed nudge economics. The idea is that a skillful nudge from government can get people to do things that are good for them but that they otherwise might not do. Examples include the administration’s proposal for automatic worker enrollment in 401(k) retirement savings plans.
"Traditionally, the retirement savings community and public policy have focused on how best to further the accumulation of retirement savings," Iwry told The Fiscal Times. "Recently there has been a growing recognition that it would be desirable also to give more attention to decumulation — how to make the savings last once accumulated, especially in a world where the individual retiree has to cope with a variety of risks, both financial and personal."
A Multisided Wrangle
The agencies’ request has set off alarm bells among employers, many of which have spent the past 30 years getting rid of their costly traditional pension plans and the investment and longevity risks they entail. They fear that the request might signal the beginning of a movement toward requiring them to build into their 401(k) and similar plans some mechanism that would allow retirees to convert their account balances into a guaranteed lifetime income or annuity. They say their experience has been that employees by and large prefer to receive their retirement benefits as a lump sum rather than as a stream, and therefore employers could end up being forced to make expensive changes to their retirement plans that workers do not want.
"Generally, with respect to benefits, we shudder at the thought of additional requirements, because it’s a voluntary system, and to load employers down with a bunch of requirements on accumulation and decumulation" can discourage them from offering retirement plans at all, said Kathryn Ricard, vice president for retirement policy at the ERISA Industry Committee, an association of large employers.
Insurers, however, see a golden marketing opportunity for a product that’s historically been more popular with economists than consumers. "From the perspective of the life [insurance] companies, this is something whose time is coming," said Walter Welsh, senior vice president of the American Council of Life Insurers, a trade group. "The Department[s] of Labor and Treasury are both looking at annuities … as a way of getting [retirees] the lifetime income they would have gotten from" a traditional pension but that they don’t get from a 401(k) or similar plan.
Thus, it appears the issue of retiree income security is about to become the subject of a multisided policy wrangle. Among the players: employers, who oppose additional government requirements on their retirement plans; insurers, who see a golden marketing opportunity; financial planners and advisers, who during the market boom tended to pooh-pooh annuities but are now more receptive to them; and the government, whose officials say they are not looking only at annuities but are open to any and all ideas that would help prevent retirees from running off a cliff.
Annuities: The Good, the Bad and the Ugly
Annuities are available from insurance companies now, and a retiree who wanted to ensure a lifetime of income could purchase one today. But even insurers agree that the contracts can be complicated and the choices hard to understand. Annuities can be immediate, meaning they begin paying right away, or deferred, meaning they begin paying sometime in the future. They can also be "fixed," meaning they pay a certain set sum, or they can be "variable," meaning their payout depends on the performance of some factor, such as the stock market.
The contract that most resembles a traditional pension is an immediate fixed life annuity in which the buyer pays the insurer upfront, and the insurer begins making monthly payments immediately and promises to keep making them as long as the purchaser lives. These contracts can include a survivor benefit, which pays someone else, typically a purchaser’s widow or widower, for the remainder of his or her life.
Annuities have not been as popular as perhaps one might expect for several reasons. First, they are very interest-rate sensitive, so that in periods when interest rates are low, as they are now, the upfront payment buys a lower stream of payments. Today, an upfront payment of $100,000 would buy a 65-year-old man an annuity paying a bit over $600 a month, depending on where he lives. A few years ago, it was closer to $700 a month. Rates quotations are widely available on the Internet.
Other deterrents include the fear that if the purchaser dies prematurely, he doesn’t get his money back. Buying an annuity also ties up a big chunk of cash, perhaps all, of the purchaser’s savings, making the money unavailable for a large, unexpected expense. And, too, many retirees hope to have enough money left to make a substantial bequest to an heir—which isn’t possible if the annuity contract has taken all the cash assets.
Insurers are answering these objections with features like guaranteeing that the stream of payments will continue to heirs for a certain number of years, if the purchaser dies early. But of course these features cost money and generally reduce the size of the monthly payment the contract promises.
Time for a Nudge from Government?
Further complicating the decision of how to manage assets in retirement are the emotions that swirl around the transition from work to retirement, "The psychology is huge," said Mary Malgoire of the Family Firm, financial planners and advisers in Bethesda, Md. "Most retirees today have a real shock in that they have had this, for the most part, decent paycheck and have figured out a way to live within it, and [suddenly at retirement] it goes down to 50 percent or something less than that. They look to this pile of money and they say: What do I do with that? The pile looks big to some people, small to others," Malgoire said.
For many, "the inclination is to do something that will make this go away. People think, I’ll just go buy an annuity and that will solve my problem," she said. But many retirees have desires that conflict. They want to make their money last, but are fearful of tying it all up in an annuity — What if I get sick and have big doctor bills? They want to keep up their standard of living — What do you mean, I can’t take the family to Italy? — but want to leave an inheritance for their children.
Further, because annuities are complex, choosing the best one can be hard. Also, how good is the company behind the annuity? There are industry guarantee systems, but they are not as reassuring as government backing. “It is a challenge for retirees to protect themselves against longevity risk — the risk of outliving their resources — and to do so without falling into other problems, such as paying too much, buying a product they don't understand, or dealing with counterparty risk--the concern that the entity they're relying on might not be able to support its promises in 30 or 40 years,” Treasury’s Iwry said.
The question, then, says Iwry, is: "Is there a useful and efficient role that public policy can play here? If so, what form should that take?"
Experts, associations, financial advisers and the general public are all invited to comment before May 3. The request is available on the Internet at www.dol.gov/federalregister/HtmlDisplay.aspx?DocId=23512&AgencyId=8