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May 18, 2008 at 04:00 PM
There is a new movement among insurance company record keepers for defined contribution plans. This is the move to provide guaranteed income riders as a new investment choice on 401(k) platforms.
These products seem like they should be an immediate hit for participants who are approaching retirement and who are concerned that they might outlive the income stream their assets could provide.
But some advisors question the necessity of having a guaranteed income rider in a 401(k) plan. They maintain that 401(k)s are accumulation vehicles–”if participants want a guaranteed income stream, they can buy an immediate annuity when they retire.” These advisors are trying to rationalize the extra cost of the guarantee during accumulation, particularly for younger participants with a long horizon until retirement.
Accumulation versus decumulation: Part of the problem is that many advisors evaluate the guaranteed income rider for the value it provides during retirement, when participants are decumulating assets. It is hard to blame the advisors, as insurance company marketing, including the names marketers give these products (e.g., “guaranteed income”), point in that direction.
What is overlooked is the value these riders provide to participants during the accumulation phase of retirement planning, especially in the later working years. This is when participants tend to grow more concerned about their 401(k) balance value.
Building a bridge: It has been well chronicled that investors, when left to their own devices–as they are in self-directed 401(k) plans–make predictably poor decisions. They become more aggressive at market tops, and sell at market bottoms. Herein lays the unappreciated value of the guaranteed income rider.
Such riders let participants stay invested through market cycles, even in the later years of their working careers when they are more prone to panic.
The graphic shows how such a rider could help participants build a bridge to retirement, even if a volatile stock market occurs in the later working years.
It shows 2 imaginary participants, Rhonda River and Bobby Bridge, who experienced the same imaginary market scenario–many years of solid growth giving way to a prolonged correction and subsequent recovery.
For simplicity’s sake, let’s assume that Rhonda River and Bobby Bridge are the same age, had the same starting account value and subsequent contributions, and were invested in the same lifestyle growth fund. The only difference is Rhonda had no guaranteed income rider while Bobby did.
