The Retirement Security Project released a paper today on “Increasing Annuitization in 401(k) Plans with Automatic Trial Income.” The paper was released in conjunction with an event hosted by the Hamilton Project at the Brookings Institution.
According to the paper's authors, William G. Gale, Director of the Retirement Security Project and Economic Studies Director at the Brookings Institution; J. Mark Iwry, Principal of the Retirement Security Project; David C. John, Principal of the Retirement Security Project; and Lina Walker, Research Director at the Retirement Security Project; an estimated 75 million Americans will retire over the next few decades, many of them with larger balances in their retirement accounts and fewer sources of longevity protection to ensure their retirement resources last throughout their lifetime than current retirees. The paper proposes a strategy that would increase the role of lifetime income products in future retirees' overall retirement planning.
“A major challenge for retirees is deciding how to best allocate their resources when they do not know exactly how long they will live,” notes Lina Walker. “If they live longer than expected, they face the dire prospect of running out of funds late in life. Alternatively, they run the risk of being too conservative when drawing down their resources and sacrificing quality of life.”
The paper highlights the benefits of lifetime income in helping retirees manage their retirement funds to maximize benefits. Consumers purchasing lifetime income typically exchange a portion of their retirement savings for guaranteed periodic payments from a provider. With lifetime guaranteed income, consumers never have to worry about outliving their funds if they live longer than expected or about actively managing their resources to ensure they do not consume too much or save more than necessary over time. Annuity providers assume the risk that any consumer will live longer than expected (which would require longer-than-expected payments) by diversifying and spreading this risk across a large pool of consumers with different survival probabilities.
Despite the potential benefits, few retirees purchase lifetime income products through the private market, perhaps due to cost, lack of consumer understanding, or a bias against lifetime income products.
The authors propose addressing cost factors by making it easier for a substantial number of retirees to choose lifetime income: the increased volume of sales would reduce prices and make them a better value for the average consumer.
To address the lack of consumer understanding and bias, the authors propose giving retirees an opportunity to “test-drive” lifetime income. Giving plan participants a chance to experience periodic, monthly income payments for a short period of time could reframe their view of lifetime income products, which would help overcome existing biases and give them more time and information to evaluate their retirement distribution options.
Specifically, the authors propose that a substantial portion of assets in 401(k) and similar plans be automatically directed (defaulted) into two years of trial income, payable as 24 consecutive monthly payments, when retirees take distributions from their plan. Individuals could affirmatively choose not to participate. At the end of the trial period, retirees could elect an alternative distribution option or, if they do nothing, be defaulted into permanent lifetime income. Plan sponsors would be encouraged to offer the trial income arrangement and would have discretion over some of its structure and implementation.
“Ten years ago, the government defined and approved automatic enrollment as a first step toward transplanting some of the traditional virtues of the defined benefit pension plan into the 401(k),” said co-author Mark Iwry, Principal of the Retirement Security Project. “With that came automatic investment – sensible default investments for 401(k)s. Our current proposal would help take the final step in the strategy of “DBifying” the 401(k) by seeking to use an automatic approach to revive annuity or lifetime income distributions.”
The authors note that several important issues would have to be resolved before such a strategy could be implemented. Their proposal maps out the first of several steps toward increasing the use of income products in 401(k)-type plans, with the ultimate goal of enabling improved retire¬ment outcomes for workers.
“Future retirees are expected to retire with larger retirement assets, live longer than current retirees, and have fewer sources of longevity protection,” notes William G. Gale, Director of The Retirement Security Project. “By reframing the way individuals view their retirement choices, helping them better evaluate their options, and incorporating automatic features in 401(k)-type plans to facilitate the selection of income solutions, we can give consumers the tools they need to make better decisions, and ultimately, to enhance retirement security over the course of their lifetime.”
For full paper, click here: “Increasing Annuitization in 401(k) Plans with Automatic Trial Income”
About the Retirement Security Project (www.retirementsecurityproject.org)
The Retirement Security Project is supported by The Pew Charitable Trusts in partnership with Georgetown University's Public Policy Institute and the Brookings Institution. It is directed by William Gale, also Director of Economic Studies and Co-Director of the Tax Policy Center at The Brookings Institution; with Principals Mark Iwry, Non-Resident Senior Fellow at the Brookings Institution and David C. John, Senior Research Fellow in Retirement Issues and Financial Institutions at the Heritage Foundation.
Pew is no longer active in this line of work, but for more information visit the Retirement Security Project on PewHealth.org.