Two professors have proposed a new kind of annuity; a product offered not by insurers, who can't promise they'll still be around to make payments when the annuitant wants them, but by the federal government.
In an op-ed piece published Feb. 26 in The New York Times,the authors, Terrance Odean, a finance professor at the University of California, Berkeley, and Henry T.C. Hu, a professor at the University of Texas School of Law, proposed a solution in which investors would "face no more risk of default than that associated with Treasury bills." Additionally, the annuity wouldn't cost the government anything, as it's an "incremental move" beyond issuing inflation-adjusted bonds.
"By allowing the government to tap a new class of investors, the cost of government borrowing over all would probably drop," the authors wrote.
"Economists agree that annuities make sense," Odean (left), told AdvisorOne on Thursday. "Defined-benefit plans are essentially annuities. If you die young, you collect less; and if you die old, you collect more."
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The proposal, he said, is a "mechanism for turning defined-contribution plans into a retirement payout scheme."
The authors suggest that when individuals enroll in a qualified retirement savings plan, say, a 401(k), instead of investing in stocks, bonds and mutual funds, they would be able to choose an annuity option. Payouts would be based on bond interest rates, mortality tables, and administrative costs, among other things.
Purchasing an annuity from the government rather than an insurer can reassure investors that they will be able to collect. There's a "reasonable expectation that people don't trust rating agencies," Odean said, especially when trying to determine which insurers are likely to still be solvent when it's time for an annuity to pay out. "I'm a finance professor and I don't know," he joked.
There may be a general sense of mistrust of the government, but Odean argued that it won't be a factor in investors' decisions to choose a government annuity.
"This is a highly specific issue; you may not trust the government to do other things, like protect your privacy, or not tap your phones," Odean said. But, it's unlikely for Treasury to default. "Could they, yes," he said, "but it's not likely." Furthermore, "the rest of the world has shown a willingness to trust the United States to pay off debt."