A 20% annuity allocation in 401(k) accounts with at least $1,000 in assets would enhance retirement security for most retirement savers, a new study finds.
The study, published by the National Bureau of Economic Research and titled "Defaulting 401(k) Assets into Payout Annuities for 'Pretty Good' Lifetime Incomes," makes a strong case for providing automatic annuity investments within 401(k) plans.
An annuity deferred to age 80 would be particularly beneficial for higher-earning groups like college graduates, according to the report. Workforces associated with lower earnings and lower longevity would likely benefit more from annuity payments starting at age 67 or 70.
Other findings show that a default-based approach for retirement income payouts from defined contribution accounts would allow for lower costs and enhance overall value for participants, thanks to greater economies of scale. Another potential benefit is the fiduciary oversight provided by retirement plan administrators.
The analysis was put together by retirement researchers Vanya Horneff, Raimond Maurer and Olivia Mitchell. As the authors explain, retirement plan sponsors can offer opt-in annuity investments within 401(k) plans but are still mostly barred from automatically enrolling savers in investments that include annuities.
Lawmakers in previous Congresses have introduced the Lifetime Income for Employees Act to change this, the authors point out. Short of the ability to auto-enroll savers into partial annuitization, the report concludes, employers and advisors should make a concerted effort to include annuity investment options and educate savers about their virtues.
Popular Policy
According to the report, prior industry and government research has found that up to 70% of survey participants say they would stick with an auto-annuity allocation that was reasonably priced.
This finding is borne out in an examination of non-U.S. retirement savings systems where default annuities are an accepted policy. For example, the paper recounts a case study reviewing 10 firms offering retirement programs in Switzerland, nine of which had an annuity as the default payout, with full or partial lump sums as alternatives.
“The evidence confirmed that a large majority of participants elected the employer-provided default option,” the authors note.
Similarly, the report notes, U.S.-based researchers have documented that real-world U.S. retirement plan participants demonstrate significant interest in annuity payouts once they are fully educated about their options.
Challenges and Considerations
When designing a default solution, it is important to consider potential rational reasons for not annuitizing. These include factors such as having a below-average life expectancy or low levels of retirement saving, the authors note.
Should it become possible to use default annuity allocations, the report details, employers and their advisors would need to answer two key questions. First, when and how much of the retiree’s accumulated retirement savings should be used to purchase a life annuity? And second, what type of life annuity should be selected?
Currently, several regulations would restrict the available options, including rules that limit the use of accumulated 401(k) assets for qualified longevity annuity contract purchases of over $210,000 — an amount indexed to inflation — while requiring that annuity payments begin no later than age 85.
Another consideration is Department of Labor guidance mandating that retirement plan fiduciaries maintain prudence and loyalty in the selection of investment options offered. This guidance primarily addresses the accumulation phase of retirement savings rather than the systematic drawdown of assets.
As the authors observe, the rules are “silent” on whether default annuities could be included as a default option for participants who make no payout election. For these reasons, the authors conclude, defaulting participants into an annuity within a target-date fund would require a clear opt-out opportunity, and conventional annuities do not usually offer this.
“In sum, while QLACs are permitted by the IRS for use in retirement plans, they are not currently allowed as a default payout product in an employer sponsored DC plan,” the researchers warn. “As mentioned, the Lifetime Income for Employees Act would permit retirement plan sponsors to use annuity contracts as QDIAs, provided certain conditions are met. While that bill has not yet passed, its provisions could still be incorporated into another bill.”
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