The Secure Act passed by Congress at the end of 2019 is the biggest change in U.S. retirement savings policy since the Pension Protection Act in 2006. The Secure Act aims to expand retirement savings opportunities, give retirees more freedom on when to withdraw their retirement savings from IRA plans, and expand access to annuities in 401(k) plans.
Annuities might be the most important part of the new law, but also the most challenging. Annuities offer valuable protection against outliving your savings. But annuities also can be very complex and difficult for consumers to compare, making it harder for retiring employees to ensure they purchase an annuity that fits their needs at the best possible cost.
I think every retirement plan should offer basic but high-value annuity options to give retirees more peace of mind in retirement. For more complex annuities, the insurance industry, state insurance regulators and retirement researchers should work to inform Americans how to choose the best plan, just as these same groups have improved the buildup phase of 401(k)s through increased use of automatic plan enrollment and low-cost target date investment funds.
Annuities protect retirees against the risk of outliving their incomes. Even if you know you’re in a group with an unusually long or short life expectancy — say, white women or African-American men — there’s a lot of variation even within that group. As a result, a lump sum of retirement savings could end up being either too much or too little. An annuity spreads that risk longevity and helps ensure a steady income for however long you might live. That’s valuable protection, and can help retirees solve the problem of how quickly to spend down their savings.
While traditional pensions may be disappearing outside of the government sector, annuities offer the opportunity to make 401(k)s more pension-like. Many retirees should appreciate that.
And yet very few U.S. retirees currently purchase annuities. To be sure, there are some good reasons for that. First, most Americans receive about 40% of their income from Social Security, which already provides an inflation-adjusted annuity payment. While annuities are very valuable, the value of additional annuitization beyond what Social Security provides is probably less so.
Second, retirees tend to spend less as they get older, even counting health-care costs, so a fixed annuity at retirement age might provide them too little income early in retirement and too much later.
Nevertheless, creative annuity design can help get around these problems and make annuities a more attractive product to retirees.
While it wasn’t previously illegal for 401(k) plan providers to offer annuities, the Secure Act offers a “safe harbor” for providers that offer annuities that are state-licensed and audited and maintain the cash reserves required by the insurance commissioner of their state. As a result, we can look forward to annuities being a more common component of retirement plans and, hopefully, retirees’ incomes.
The most straightforward benefits come from plain life annuities that pay a guaranteed amount each month for as long as you live. Some households might wish to purchase an annuity at the time they retire, to effectively convert their 401(k) balance or other savings into a pension-like monthly check. Others might purchase a deferred annuity — say, beginning at age 85 — that could inexpensively guarantee against an inadequate income in very old age. Annuities should also offer joint-and-survivor options, providing a benefit for a surviving spouse or partner.
Here’s where it gets complicated
While every retirement plan should offer these basic but high-value options, that’s already a lot of choices for people to make. And as annuity options become more complicated, the value proposition does as well. For instance, some people might want a variable annuity that invests in riskier but higher-returning assets, while still providing longevity protection. Others might want a period-certain annuity, which pays out for a guaranteed number of years regardless of how long you live. Others might want an annuity that protects against inflation, whatever it might be. Yet others might want an annuity where payments rise at some fixed percentage each year, account for rising prices but at a lower cost than true come-what-may inflation protection. In theory, you can have an annuity tailor-made to your own circumstances. And in general, that’s a good thing.
Where it gets complicated is in comparing annuity prices. An employer looking to sponsor a retirement plan will want to know how much competing providers charge for their products. And an employee facing retirement will want to compare different annuities before deciding what to purchase.
But pricing an annuity isn’t intuitive; there’s little way an employee facing retirement could easily tell which option offers him the best deal. And, let’s be frank, there are incentives for providers to offer complex annuities where prices aren’t easy to compare over plain-vanilla life annuities that are essentially commodities.
The National Association of State Insurance Commissioners has a working group dedicated to generating model legislation mandating minimum disclosures for annuity purchasers, which would include both disclosures of fees and illustrations of how different annuity payout options might work. That will help employees make better choices when offered annuities.
Retirement researchers also have a role to play. The past several decades have been very fertile for retirement researchers, and that research has prompted action with regard to automatic enrollment in 401(k)s, reduced 401(k) fees and the dramatically increased use of target-date funds. Those same researchers can apply themselves to in-plan annuities, helping describe the best types of annuities for retirees and ways that annuity options and fees can be explained to 401(k) participants.
Annuities in 401(k)s offer significant opportunities for improvements to retirement income security. But there are also risks that retirees won’t know how to compare the many options that might be available to them. And a couple of bad stories might discredit all annuities, scaring retirees off from a product that could otherwise help them. The Secure Act opened the door to annuities in 401(k) plans, and now retirement plan providers have the chance to roll out products that will give Americans more peace of mind in retirement.
