By: Dan Kadlec
May 16, 2012
One of the biggest flaws in most people's retirement plan is something that previous generations rarely worried about: monthly income guaranteed for life. But the fix is in, and before long your 401(k) may look a lot more like your dad's pension.
That's a good thing. Traditional pensions that pay a set monthly income to retirees, based on their wages and length of service, were once the foundation of retirement. Along with Social Security, this benefit covered the bulk of a retiree's fixed costs until death. No worries. Personal savings (such as those in a 401(k) plan) were simply gravy.
But that formula has been turned upside down. Only one-in-three workers under age 35 are even eligible for a (greatly reduced) traditional pension benefit -- and just 8% of all workers expect such a pension to be their main source of financial security. Instead, today's workers will have to lean heavily on their own savings, ideally salted away over time in tax-deferred accounts like 401(k)s and IRAs.
That raises the specter of vast numbers of Americans outliving their bank accounts--which is a crisis on both the personal and policy levels. A stunning 49% of Americans say they aren't contributing to any retirement plan, according to a new survey conducted by LIMRA, a trade association for the financial services industry.
With retirement Armageddon on the horizon, we are finally getting a meaningful response on a large scale. Big employers have begun exploring efficient ways for workers to shift 401(k) assets into an investment option that guarantees income for life--making the 401(k) more like a traditional pension. One option, which has been around for a long time, is an insurance product known as an annuity, where you pay maybe 30% of your 401(k) balance in return for a lifetime income stream. But more sophisticated products are in the mix, too, seeking to offer more generous income streams for similar amounts of money and risk.
One in five employers expect to introduce such an option in the next 12 months, according to the 2012 BlackRock Retirement Survey. That would double the number already offering such an option. "At nearly every meeting we go to this is something we talk about," says Chip Castille, head of BlackRock's defined contribution group in the U.S. and Canada.
The benefits of such a shift would be profound, even beyond the provision of economic necessities. The BlackRock survey found that retirees with a guaranteed income stream are far more confident about their finances. Other surveys have found that those with a guaranteed income stream are happier, too. One study found that retirees with a traditional pension are more content than those with the same level of wealth but no pension, and that retirees who have both a pension and a 401(k) are even happier.
Adding a lifetime income option to 401(k)s could have another benefit as well: improving our savings rate. Many of those who are not putting away money now have shied away from 401(k) plans in part because the plans have been dead money for a dozen years. The stock market has been a bust. Workers might save more if they felt more certain about the benefits.
Nearly all workers believe their 401(k) plan should have a guaranteed income option and three-in-four employers believe it is their responsibility to provide one, BlackRock found. This represents a seismic shift in thinking, and it is occurring throughout the financial and employer community. Virtually all of the big players are looking at adding a sensible annuity option to their plans and educating workers as to how that option can best be incorporated in their own strategy, says a BlackRock spokesman.
Just a few years ago, employers were reluctant to even consider annuity-like options. They were seen as too conservative; 401(k) plans were meant to build assets over the long haul. But as 401(k) plans emerged as the prime source of savings for most workers, this view softened. The 401(k) plan, once the gravy, is now the meat and potatoes of retirement security. As such, a guaranteed income component is seen as appropriate and, indeed, the federal government has begun to openly encourage employers to build one into their plans.
"It is important for savers to have some form of guaranteed income to prevent them from running out of money," says Catherine Collinson, president of the Transamerica Center for Retirement Studies. "The idea clearly resonates with workers and there is a lot of movement in Washington to help plan sponsors make these options more widely available."
Some 43% of American adults believe retirement income is such an important issue that it should be a priority for the next president and congress, according to a Transamerica survey Redefining Retirement: The New Retirement Readiness. They want the government to encourage 401(k) plan sponsors to offer to pay benefits in a form that guarantees a set level of monthly income, regardless of how long one lives.
The push for guaranteed lifetime income has at least one big obstacle. Current interest rates are so low that purchasing monthly income through an annuity is unusually expensive. One risk is that savers given this option will switch at just the wrong time--converting low 401(k) balances from the recession into guaranteed income at the priciest levels in many years.
That underscores the central difference between your dad's pension and whatever your 401(k) offers. Your 401(k) is self-funded and self-managed. You must determine what makes the most sense and how much to pay for it. The income option is a welcome addition to the menu. But a no-brainer it is not.