More Americans are preparing to turn 65 than at any point in history. Many, however, will lack sufficient savings to supplement Social Security and provide income lasting through decades of retirement.
Annuities have traditionally played a role in boosting post-retirement income, albeit outside of employer-sponsored benefits. That could change, as retirement plan sponsors reconsider the use of annuities in tandem with 401(k)-style defined contribution plans.
With annuities, a consumer makes a lump-sum payment—or series of payments—to an annuity provider such as a life insurance company, and in return receives regular monthly payments, generally at retirement or beginning at a specified post-retirement age. These payments are guaranteed to continue throughout the retiree's (or the retiree's spouse's) lifetime, however long that might be, which is why they're referred to as protected income.
Jason Fichtner is the author of a new report, The Peak 65 Generation: Creating a New Retirement Security Framework, published March 30 by the Alliance for Lifetime Income, a nonprofit coalition of ﬁnancial companies that supports the wider use of annuities and other guaranteed income products within employer-sponsored retirement plans. He is a senior lecturer at Johns Hopkins University's Paul H. Nitze School of Advanced International Studies, a senior fellow with the Alliance for Lifetime Income, and previously served in several positions at the Social Security Administration under presidents George W. Bush and Barack Obama, including deputy commissioner of Social Security (acting), chief economist and associate commissioner for retirement policy.
SHRM Online asked Fichtner about the role annuities can play along with, and within, employer-sponsored 401(k) defined contribution plans.
A Bridge to Social Security
SHRM Online: The "normal retirement age" for claiming full Social Security benefits is after age 66 for most working Americans and age 67 for those born in 1960 and later. As you've noted, retirees who claim early Social Security benefits after turning 62 will receive monthly benefits reduced by 25 to 30 percent throughout their retirement years. However, those who delay claiming Social Security past their normal retirement age will see their eventual benefit increase by 8 percent for each year that they hold off, up to age 70.
You've written that lifetime income investments could be a way to help more retirees delay Social Security and receive larger payments later. How so?
Jason Fichtner: People who lose their jobs after age 62 but before their normal retirement age, as many did during the COVID-19 pandemic, often have no alternative to claiming Social Security benefits early. If they had an opportunity to direct at least some of their defined contribution plan assets into an annuity product, or if, after retiring early, they were given help to purchase a short-term bridge annuity with at least part of their 401(k) assets, that could allow them to delay Social Security until their full retirement age or even until 70, increasing the amount of Social Security income they would receive each month.
SHRM Online: Addressing employees' hesitancy to trade a significant portion of their plan assets to purchase a lifetime income product as they retire, you point to "trial annuities" as an interesting approach. What are these?
Fichtner: A product such as TIAA's Income Test Drive lets someone experience the benefits of protected income but allows them to cancel at any point during a two-year trial period and receive back the lump-sum purchase price minus the value of payments received. There's no cost or penalty to cancel during the trial period, and the annuity payments will continue at the end of the trial period if not canceled. Retirees can try out the benefits of an annuity and start getting monthly protected income payments and see how they like it.
This is a way to get over what behavioral economists call "loss aversion," the hesitancy over exchanging a large portion of retirement plan assets for annuitized income.
SHRM Online: Aside from helping retiring employees to purchase annuities with at least some of their plan assets, what role could annuities play as an investment option within 401(k) plans?
Fichtner: Including annuities as a savings option allows employees to buy a future stream of guaranteed income as they purchase other financial assets within the plan. It's a way to avoid the loss aversion that prevents many from using their accumulated savings to purchase an annuity at retirement.
In-plan annuities help avoid the loss aversion associated with using 401(k) savings to purchase lifetime income at retirement.
If they can start accumulating future protected income within the plan, then plan sponsors could show participants, in addition to how much of their portfolio is invested in stock and bond funds, how much is going into protected income and how much protected income that will buy them at retirement. By the time they're ready to retire, they won't have to worry about giving up that lump sum, because it will already have been invested for them in an annuity product.
Within Target-Date Funds
SHRM Online: There is growing talk about including annuity investments within target-date funds. People who are defaulted into the target-date funds would have part of their money annuitized if the fund itself included an annuity portion within its holdings. How do you view this approach?
Fichtner: I'm hoping to see more annuities as investments within target-date funds, the common default investment for automatic enrollment plans. It's not widespread yet. I think mutual fund companies are trying to figure out how to do it and how to price it. Nationwide is coming out with a product relatively soon. But the default option is so powerful for retirement security that if you start getting the annuitized option into a target-date fund, the default is going to have the power to help move the needle. Then we'll start seeing competition as these products spread.
SHRM Online: What would the annuitized portion of the target-date fund be? Is the fund actually purchasing a lifetime income product?
Fichtner: There are a variety of ways it can be done. As the fund buys different assets, they could also start buying, through an insurance company, an annuitized product that could begin to spin off income as of the fund's target date. A portion of the fund's share price would go to buy a portion of an annuitized product, in addition to stock and bond holdings, and that becomes part of the asset mix of the fund. It would be inside the fund, and that portion of the annuity ratio would grow over time.
Reporting Lifetime Income Estimates
SHRM Online: The Setting Every Community Up for Retirement Enhancement (SECURE) Act, signed into law at the end of 2019, requires plan sponsors to annually disclose on 401(k) statements an estimate of the monthly payments participants would receive if their total account balance were used to purchase an annuity for the participant and the participant's surviving spouse. The Department of Labor will devise assumptions 401(k) plans can use to estimate the monthly income that participants' 401(k) balances are likely to generate over their lifetime, and the disclosure must be made on participants' 401(k) statements a year after regulators finalize those assumptions, which are still pending. Will this spur plan sponsors to adopt lifetime income strategies and plan participants to take advantage of them?
Fichtner: I think it's a great idea [to report lifetime income estimates]. This is similar to what the Social Security Administration has been doing when they let employees go online and see their estimated Social Security payments. When more people had defined benefit pensions, it gave them the security of knowing how much income they would be receiving. With 401(k) assets, they don't know how long it's going to last. If they invest those funds post retirement [outside of an annuity], they don't know what the rate of growth, or loss, will be.
SHRM Online: The SECURE Act requires a projection of annuitized lifetime income based on the value of assets currently in the participant's account, but some argue it would be more useful to project annuitized income based on an estimate of what the account value is likely to be at the participant's normal retirement date. Is that a better idea?
Fichtner: It would be beneficial to report both. If plan participants are just starting out, if they're in the 20s, for instance, their 401(k) balance is not going to be projected to generate a lot of protected income at that point in time, so it's not so helpful to say, "Here's your balance and here's what you'll get if you annuitize the value of your assets now."
But it's important to show that figure and then say, "If you continue along this path, here's what you could expect to see in protected income at age 62, 67 or 70, based on your earnings history and what it would be if you were to continue along this pace. It would be clearer to participants that if they were to earn more and increase their contribution rate, that projection would go up.
You want people to understand why they should be saving today, because before they know it, their retirement will be here and they'll be looking back and saying, "Why didn't I save more?"
Related SHRM Articles:
DOL Requires 401(k)s to Give Participants Lifetime Income, SHRM Online, September 2020
SECURE Act Alters 401(k) Compliance Landscape, SHRM Online, January 2020
Risk vs. Readiness: The 401(k) Plan Annuity Conundrum, SHRM Online, February 2018