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Over the past generation, the U.S. retirement system has moved away from offering traditional pensions -- and their promise of a steady stream of income for life—and toward investment accounts that Americans must manage on their own. Now the tide may be turning back.
A leading proponent of such change is J. Mark Iwry, senior adviser to the Secretary of the Treasury and deputy assistant secretary for retirement and health policy. The federal government is proposing new regulations to make it much easier for annuities and other forms of steady income to be included in 401(k) retirement plans and individual retirement accounts (IRAs).
Bloomberg’s Ben Steverman asked Iwry why the changes are needed and how they might affect Americans saving for retirement. Edited excerpts of their conversation follow.
Q: How prepared are Americans for retirement?
A: Too many of us are far from where we need to be. This is something Americans are struggling with. Social Security provides the crucial bedrock foundation for financial security in retirement. But it’s not intended to do the whole job.
Women have a particularly tough challenge in providing for themselves in retirement. On average, women live longer than men and have a greater chance of living into their 90s. Yet women have less retirement savings -- largely because they spend fewer years earning wages on a full-time basis in the workplace -- and less retirement income than men. That’s part of the motivation for [this] project: Lifetime income solutions are likely to be particularly helpful for women.
Q: You’ve introduced proposals to make it easier to offer annuities and other income products in retirement plans. What problems do these address?
A: Helping manage longevity risk. Let’s say you’ve reached retirement age. You’ve got your pot of money accumulated in a 401(k) or IRA. For many people, figuring out how to manage that pot of money is an unprecedented challenge. What’s a prudent withdrawal rate, and how do I use it to replace my former paycheck?
You start with the fundamental uncertainty about what lifespan to plan for. At age 65, a man has about an even chance of living to age 84 and a woman has about an even chance of living to age 86. For a married couple, there’s a good chance that at least one of them will live into their 90s.
Given uncertain investment returns and the possibility of outliving your life expectancy, many financial planners explain it’s not prudent to withdraw more than about 4 percent of one’s savings every year. (That assumes you make no adjustments over time in response to changing circumstances.) A typical reaction is, “Gosh, I’ve got a quarter of a million dollars in my account. That feels like a lot of money. But 4 percent of $250,000 is only $10,000 a year to add to Social Security. That’s not enough. So what do I do?”
Q: How are you trying to change the current retirement system to solve that dilemma?
A: One solution is to provide for a predictable lifetime stream of income, such as an annuity provided under a retirement plan or IRA. By pooling those who live shorter and longer than average, everybody can essentially put away what’s necessary to reach the average life expectancy, and those who live longer than average will be protected. The longevity risk pooling means that an annuity might provide an annual income of more like 6 percent or 7 percent, rather than 4 percent, depending on interest rates and the terms of the annuity.
We’re trying to make it easier for people to choose lifetime income if they want to; make it easier for the financial services community to offer these options; and make it easier for employers to incorporate retirement income options into their plans, whether 401(k)s or defined benefit pensions.
Q: And longevity insurance is one option that you’re expecting plans to offer?
A: A longevity annuity or longevity insurance is a stream of income that is deferred -- the beginning of that income is postponed -- until an advanced age, such as 80 or 85. So this annuity doesn’t start until about the time you’d reach your life expectancy. It’s based on the theory that people have the hardest time planning for the management of their savings for years beyond their life expectancy -- the “tail risk” of outliving their assets.
IRAs and 401(k)s, which hold $8 trillion to $9 trillion in assets, are, as a practical matter, precluded from offering longevity insurance by the required minimum distribution rules. We’ve proposed to amend those rules to accommodate the offering of longevity annuities as an option.
Q: So if this goes according to plan, our readers are going to see more chances to buy annuities through their 401(k)s.
A: That’s right; the range of choice in those plans should expand. We’re also focused on defined benefit pension plans, which often offer the choice of an annuity -- which will last your whole life -- or a lump sum. If framed as an all-or-nothing choice, too often people pick the lump sum. We’re trying to encourage plans to get away from an all-or-nothing “choice architecture.”
Q: Annuities can be very complex products. Won’t these changes make retirement decisions even more complicated?
A: Actually, we hope this initiative will make it simpler and easier for people to understand, evaluate, and choose lifetime income options. It can be a lot easier for individuals to navigate the system when their plan -- the employer -- has arranged for retirement income options. Greater involvement by plan sponsors may mean more bargaining power and professional assistance for employees.
Simplifying the process, encouraging more options, more transparency, and better disclosure should ultimately make it easier for people to understand their choices and bring costs down.