Leading the Horse to Water
The market’s recent plunge likely frightened more Americans into a willingness to consider putting at least some of their 401(k) assets in a retirement-income product at retirement. Now, Congress may give them a nudge to go ahead with it.
Support for tax advantages for annuities, previously proposed in 2005 by Rep. Earl Pomeroy (D-North Dakota), seems low this year, given the government’s other current financial demands. However, several other ideas appear to have potential traction, and they speak to the logistical and psychological reasons that many see at the heart of 401(k) participants’ continued aversion to retirement-income products—the overall inertia, concerns about the complexity and cost of choosing an annuity on the open market, the fear of losing money to unstable financial institutions, and the impression that a series of small payments made over time has less value than one big lump-sum payment.
“As we bring more people into the system, we will need to address the longevity risk,” says David Certner, AARP’s Director of Legislative Policy in Washington, pointing to the Obama Administration’s auto-IRA push. “Having a better-functioning annuities market would be very helpful.”
Three Possible Solutions
These three possibilities seem the most discussed currently:
Auto-enrollment in annuities: Nonprofit public-policy researcher The Brookings Institution has proposed a “test drive” that would automatically enroll defined contribution participants in an annuity for two years after they retire. Congress would establish an acceptable range of default balance put into the annuity—say, 50% to 80%—and each employer could choose the best percentage for its workforce, says William Gale, a Brookings Vice President and Director of the Retirement Security Project. Employees could opt out or change their percentage, he suggests.
A government mandate to purchase annuities “would be a step in the wrong direction,” Gale stresses. An annuity does not work best for everyone, he says, and, even when it does work well, a bunch of variables mean no one annuity setup is right for everyone. “It is very important that these things remain voluntary,” he says. If people get the wrong annuity, he says, they “have made a big, permanent mistake.”
Gale also favors the government coming out with QDIA-like guidelines for annuities, to ease employers’ worries about fiduciary issues. “I would like to see that: ‘You tell me what the acceptable situations are, and I will pick one,'” he says. “We need a safe harbor for payout options, like we have for investment options.”
From an employer perspective, sources agree, auto-enrollment succeeds in giving many more participants access to a retirement-income vehicle. With opt-out rates low for automatic enrollment in 401(k) plans, “it is not likely that they will opt out” of auto-enrollment in an annuity, says Robyn Credico, Arlington, Virginia-based National Director, Defined Contribution Consulting, at Watson Wyatt Worldwide.
“Automatic enrollment seems to work, period,” Certner says, “so it would probably work for anything.” In this case, too, it likely would “harness the power of inertia,” he says. AARP previously backed legislation from former Illinois Sen. Carol Moseley Braun to require joint-survivor annuities as an option in defined contribution plans, he adds.
The concept has its challenges, though. “The problem is the pricing,” says Dallas Salisbury, President and CEO of the Employee Benefit Research Institute (EBRI) in Washington. “You could do it—but it would be a very expensive option, because any annuity that can be terminated at the end of two years becomes very expensive to underwrite.” He has seen an estimate that this type of annuity could carry an additional cost of 400 to 500 basis points.
Edward Ferrigno, Vice President, Washington Affairs, at the Profit Sharing/401k Council of America, also worries about any sort of annuity mandate. “We absolutely think that annuities have a role, and there is no doubt that the last year’s activity has renewed interest in this area. What is going on that we fully support is a tremendous amount of innovation [by annuity providers], he says, but it would kill that innovation if they mandated something. “For insurance companies, that is a jackpot: ‘We have your money, and you cannot get it back.'”
A federal guarantee: Some believe that automatic enrollment in annuities makes little sense without setting up a federal-guarantee structure for annuities, similar to the Federal Deposit Insurance Corp. (FDIC) guarantee of bank deposits. “The need is probably greater, because you have a lot more people who are nervous about committing money to a financial institution,” Certner says. State guarantee funds exist, he says, but their terms vary.
“I think it would make a world of difference,” Salisbury says. “It would eliminate a lot of the fiduciary-liability concerns around insurance-company failures, and the wide variations across states in what is in place.”
On the other hand, “One thing employers might be concerned about is that the whole arrangement would be subject to future changes by Congress,” says Jan Jacobson, Senior Counsel, Retirement Policy, at the Washington-based American Benefits Council, “and it would be a fairly expensive proposition.” Adds Salisbury, “Given the current fiscal situation, even if people said it was a good idea, it would take a long time to do.”
Channeling employer contributions: Brookings’ Gale also talks about using legislation to funnel employer contributions to an annuity. “It would be a default,” he says. “[The idea is that] the employer has to offer it, but it is voluntary for the individual.”
That could help with the perception issue many participants have, Gale says: They do not want to hand over a large amount of their money in return for what seems like an unequal series of small payments. “Most people do not want to buy one gigantic annuity. This would encourage people to buy an annuity in small chunks throughout their lifetime,” he says. “It is like dollar-cost averaging in a mutual fund.”
Credico likes the idea, since employers give matches to help ensure employees’ retirement security. “If I am going to care about your retirement security, I want to make sure that you have some income for the rest of your life,” she says. However, Salisbury cautions that “there is still the front-end issue of the willingness of plan sponsors to move forward with these types of options, given the fiduciary issues. There is not a whole lot of employer interest at this point.”
Ferrigno does not favor the idea at all. “We would fight that to the death,” he says, again mentioning a dislike of plan-design mandates. “If there was a demand for annuity products in a plan, they would be there. There is no demand. It seems like a lot of people are jumping to the conclusion that we have a national crisis because people do not annuitize enough of their income.”
The Brookings’ ideas undoubtedly will get a push from two of its former officials who now play key roles in the Obama Administration, Ferrigno says. Nonresident Senior Fellow J. Mark Iwry is now Senior Adviser at the U.S. Department of the Treasury, and former Senior Fellow Peter Orszag now serves as Director of the Congressional Budget Office.
“There is a lot of interest. The Administration is in favor of it, and I think Congress gets it,” Gale says. “One of the few silver linings of the economic crisis is that it is an enormous teachable moment on the advantages of purchasing an annuity. The sea change coming is going to be to think of a 401(k) not as an asset-accumulation device, but a retirement-income-provision device.”
Jacobson also sees interest in annuities in Washington, but does not expect a stand-alone bill. The ideas likely would be folded into broader retirement legislation, she says. U.S. Rep. George Miller (D-California), Chairman of the House Education and Labor Committee, was said at press time to be “in the middle of drafting a retirement bill that might or might not include annuities,” Salisbury says. “Everything at the moment is dominated by the health-care discussion. The probability of that [retirement] bill getting enacted this year is probably zero,” he predicts. “The question becomes, does it become a priority in 2010 and 2011, assuming they get health care done this year?”
“There is a lot of focus on this issue,” Certner says of retirement-income security, but he agrees that health-care legislation takes priority for now. “We are going to be having this debate; it just may not be immediately. It may be pushed off a bit.” Jacobson agrees, but adds that its near-term fate could depend on what happens with the markets in 2009—a barrage of scared and angry retirees could convince Congress to take care of the issue sooner rather than later.
—Judy Ward