The recent market downturn has stirred much debate about the ability of the 401(k) plan to provide adequate retirement income. One proposed solution to the perceived failure of the country’s most popular retirement savings program is to bring back the annuity.
Two bills recently introduced in Congress (S. 1297 and H.R. 2748) would provide tax incentives for those electing life annuities; the Department of Labor and the IRS are studying the issue; and several insurance companies have introduced products designed to guarantee a minimum lifetime income stream in retirement. The Lifetime Income Disclosure Act (S. 2832), introduced in the Senate on December 3rd, would require employers to annually notify participants of the projected monthly annuity they could expect at retirement based on their current age and account balance. Just what sponsors and participants need…yet another mandatory disclosure that will go straight into the trashcan.
There are several reasons I question this course of action. The first takes us for a walk down memory lane. I have worked with qualified plans in some form or fashion for the better part of the last two decades, and I do not recall seeing or hearing of a single participant who elected an annuity when a lump sum was available. When Treas. Reg. §1.411(d)-4 was amended in late 2000 to allow profit sharing plans to eliminate annuities as an optional form of benefit, plan sponsors could not get in line fast enough. Given relatively short memories, any urgency that would drive demand for annuities will be forgotten as soon as the market turns and unemployment drops. The economy will most likely be well-along the road to recovery before legislation is passed (trying to be a "glass half full" kind of a guy), rendering it obsolete on arrival.
The second reason is that of fees. Annuities are insurance products and insurance products carry a price tag, sometimes a hefty one. At a time when articles emphasize that an extra 1% per year in fees reduces retirement benefits by 28%, it seems more caution is needed before going gung-ho into annuities without careful scrutiny of all associated costs, direct and indirect.
A third reason that perhaps it is prudent to look before leaping is liability. DOL Advisory Opinion 2002-14A and PPA §625 make it clear that selection of an annuity provider is subject to all applicable fiduciary standards. While DOL Reg. §2550.404a-4 does provide a safe-harbor process for fiduciaries to make the selection, it requires an “objective, thorough and analytical search” that considers all relevant factors from costs to the insurance company’s ability to make all future contract payments. This is a relatively high standard for many small to mid-sized plan sponsors to meet.
The 401(k) plan was designed to be a supplemental savings plan, not a retirement plan unto itself. No matter how many bells and whistles we add or reincarnate with shiny new façades, one cannot accumulate meaningful retirement savings without having the discipline to actually save.