Recently, the Treasury Department announced regulations meant to increase the prominence of annuities in retirement plans.
On the surface, this is a great idea. With the elimination of many company-defined benefit pension plans over the past few years, the burden of funding retirement has shifted from the company to the employee. 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 major 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 an arrangement. Here are five potential wrinkles:
Annuities are generally offered and guaranteed by insurance companies. Is this how the federal government envisions this annuity option working? If so, which insurance companies would be allowed to offer these annuities? Would there be any controls to ensure that the insurers meet some minimum tests for financial strength?
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.
This type of product could take the focus away from the fact that employees still need to save a sufficient amount to fund their retirement. While an annuity may guarantee an income stream for life, there is no guarantee that this income stream will be enough to fund a comfortable retirement. The use of annuities does not relieve the employee of the burden of determining how much he will need to save to fund his own retirement. Anything that makes employees think otherwise is a bad idea in my opinion.
Many plan participants are already confused by target-date funds. A surprising percentage of retirement plan participants think that investing in a target-date fund guarantees them a sufficient nest egg. As outlined above, I fear that this same type of misinformation will be prevalent around these annuities.
Many plan sponsors do not perform a sufficient level of due diligence in the selection and monitoring of the investment options they offer or the plan provider they select. This is often the case with smaller employers, but it is not limited to that segment. The need to scrutinize these annuity products will just add to that burden and potentially result in many employees relying on sub-standard annuity products.
Again, on paper this is a good idea. However, I fear that this good idea could turn out badly for plan participants if these and many other issues are not ironed out on the front end of this process.
Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides advice to individual clients, retirement plan sponsors, foundations, and endowments. He recently cofounded Retirement Fiduciary Advisors to provide direct investment and retirement planning advice to 401(k) plan participants. Follow Roger on Twitter and LinkedIn. Roger also blogs at Chicago Financial Planner.