Having a lifetime income guarantee at age 85 may be fine, but having a retirement savings principal protection guarantee in place at age 67 is just too expensive, four economists say.
Vanya Horneff and three other economists analyze the value of principal protection in a new working paper posted on the website of the National Bureau of Economic Research (NBER).
A working paper is a preview version of a research paper. It may not have gone through the full academic peer review process.
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Horneff and her colleagues assessed principal protection guarantee costs and benefits by analyzing data from Germany’s “Riester program.”
Here are five facts about the paper, for life insurance agents and other financial professionals with an interest in the U.S. annuity market.
1. The paper’s authors are a big deal.
Horneff, an economist at Goethe University Frankfurt, previously co-authored an influential paper on the effects of persistent low returns on retirement savings.
The list of co-authors also includes Olivia Mitchell of the University of Pennsylvania’s Wharton School, who has written dozens of influential papers about retirement savings.
2. The authors give details about how IRAs work in Germany.
Germany’s Riester program offers workers a way to save money in tax-qualified individual retirement accounts that, in some ways, resemble U.S. IRAs.
Managers of the Riester program divide life between an accumulation period, when a worker is building up IRA savings, and a decumulation period, when a retired worker starts pulling money from the IRA.
German pays annual subsidies of up top 175 euros per worker, or about $192 per worker, to workers who contribute up to 4% of pre-tax labor income to their IRAs.
Life insurers hold about 65% of the Riester contracts, and asset managers hold just 20% of the contracts.
German IRA holders can start taking money out at age 62. They can withdrawal up to 30% of the accumulated assets in the form of one big lump sum. A German IRA holder is supposed to take the rest of the assets out in the form of a lifelong stream of non-decreasing, guaranteed benefits, Horneff and her colleagues write.
A German IRA holder must annuitize any assets remaining at age 85, at the latest.
“Usually, to fulfill the last requirement, IRA providers devote a share of their IRA balances at age 67 to buy deferred annuities that pay benefits from age 85,” the economists write.
When the worker shifts from the accumulation phase to the decumulation phase, the German IRA provider must provide principal protection in the form of a money-back guarantee. The guarantee applies to the money the worker paid in during the accumulation phase.
3. The authors give details about a huge new European Union IRA program.
While the United Kingdom has been obsessed with a planned Brexit, or exit from the European Union, the European Commission — the entity in charge of the European Union — has been creating a Pan-European Personal Pension Product (PEPP) program.
The PEPP program could create a huge retirement plan sales opportunity for the financial services companies that have the ability to sell PEPPs in Europe.
The PEPP program will create a standardized, tax-qualified, funded defined contribution plan, Horneff and her colleagues write.