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Annuities in 401(k) Plans-My Questions and Concerns


Recently the Department of Labor (DOL) and the Treasury asked the public to comment on whether the idea of requiring employers to offer lifetime annuities as a rollover option for 401(k) plans is a good idea.

On the surface this is a good idea with much merit. The recent volatility in the financial markets and the economy has reduced the 401(k) balances of many workers. Many plan participants feel uneasy about how to best allocate their 401(k) contributions while working and equally unsure about how to take distributions from their accounts in retirement. Poor investing combined with another market downturn could put a serious crimp in the ability of many Americans to make their nest eggs last for their lifetimes.

These proposed annuities would conceivably work much like traditional defined benefit pension plans. Workers would receive income for their lifetimes that they could not outlive. There might even be options to guarantee lifetime income for a surviving spouse or other beneficiaries.

This all sounds good on paper. My concerns center on the implementation of such a plan.

1. Annuities are generally offered and guaranteed by insurance companies. Is this how the administration envisions this annuity option working? If so, which insurance companies would be allowed to offer these rollover annuities? Would there be any controls to ensure that the insurers meet some minimum tests for financial strength?
2. Fees and expenses are a key element of any annuity product. Would there be some oversight and regulation to ensure fair and reasonable expenses? Who would define what constitutes fair and reasonable expenses? Higher fees generally equal lower payouts for annuitants.
3. Would the annuities offer inflation protection as in the public sector or would the payout remain flat as with many commercial annuities and corporate pension payments?
4. A much discussed regulatory initiative centers on making 401(k) plan fees and expenses more transparent and standardized. Often, 401(k) plans administered by insurance companies are anything but transparent regarding fees and expenses. Will the addition of this annuity option add to the confusion regarding plan fees and expenses?
5. Will annuity payments be based upon some sort of standardized formula such as age, years of service etc.? Will this formula be standardized across the all employers or will the insurers be free to offer whatever payouts “the market will bear?”
6. If an insurer offering a rollover annuity product was to experience financial difficulty who would stand behind the participant’s payments? The already strapped PBGC? State insurance regulators? Someone else?

Again, on paper this is a good idea. I fear that this good idea could turn out badly for plan participants if these and many other questions are not ironed out on the front end.

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  1. Important topic, Roger, and a great post.

    Like you, I'm always concerned about execution of the idea than I am about the idea itself.

    And while I support the concept of taking measures to better protect the retirement savings and income of consumers, I'm wary of the opportunities for this to turn into a mess that could possibly do more harm than good.

    Will be interesting to see if/how this issue develops

  2. Fixed Indexed Annuities that are currently in the market place do not have fees.

    Additionaly, some of the products offered have provisions similuar to a CLI to help keep pace with inflation.

    Sales of FIA's have grown from $3 billion in 1997 to $26.7 Billion in 2008 This may be a small market, but no one has lost a dime in a FIA. Guaranteed lifetime income is a driving factor to the growth.

    Retirees and Pre Retirees are learning it is more important to get the return of their money than a return on their money.

    While the S&P; 500 index has produced near zero total return over 12 years, the FIA using the S&P; 500 index on average produced returns of 5.79% using a 5 year annualized rolling return from 1997-2007

    I'm also concerened when government gets involved in anything…An option would be to require all plans to allow in service distributions. These distributions could be used to start a "Personal Pension Annuity"

  3. Russ, thank you for the comment. This issue has a lot of popular appeal and frankly a good deal of merit. If enacted, the details and implmentation will be critical.

  4. William, thank you for your comments. Your comments, however, lead me to believe that you might have missed the point of this post. I am not anti-annuity. The idea of an annuity/pension-like payout option has some merit. My concern lies with the implementation and regulation of such a proposal. I think you would agree that not all annuites or insurance comapnies are created equal.

  5. William, I take issue with your comment that "Fixed Indexed Annuities that are currently in the market place do not have fees."

    They do have fees, but they are buried within the structure and operations of these contracts, and you (and may people that sell these things) would be hard pressed to quantify how much these fees add up to.

    There still is no such thing as a free lunch. These companies issuing these annuities aren't doing so out of the goodness of their hearts 🙂

  6. I know I'm late to this discussion but I'm thinking that once these are neatly tucked in a 401(k), they begin to fall under ERISA rules, are subject to employee lawsuits if the transparency and fee level isn't published – more than when they are purchased outside of the plan. The fiduciary responsibility is that of the business offering the plan, not the insurance company. And this will force – with any luck – better selection on the part of all parties concerned.

    The salesperson is also absent from the process (for the employee), eliminating the pressure to sign up right away and most folks do so without paging through the 300-plus page material that comes along with the product.

    And the current state of the stock market doesn't come into play with the purchase – just the knowledge of how much a person would get each month after they invested X-amount of dollars. (Studies have suggested that this is a consideration when delivered a lump sum at retirement: good markets tend to make folks think they can go it alone, tough markets are good sell for annuities.

    This option can be particularly beneficial for women, who take a larger hit than men from the actuaries when they purchase this plan outside of a 401(k).

    Overall, no single product will do it all but having some retirement cash in an annuity inside a 401(k), acts like a pension and for some, that is exactly the kind of comfortable diversification they need.

  7. Thanks for the comment. Your points are valid and you may ultimately be right about plan sponsors doing more diligence on these products if they are help responsible as fiduciaries. On the other hand there are many high cost, low quality insurance company plans in place and and many sponsors don't even know the right questions to ask in determining if these plans are appropriate for their employees. Insurance companies and annuities scare me. I like the concept of a pension-like income stream for those who want it, I fear that many sponsors will be easy prey for insurers trying to tap this huge market unless some strict guidelines are put in place.

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