From the March 2010 issue of Treasury & Risk magazine

Mind the Income Stream

In the latest attempt to improve defined-contribution plans, annuities are being touted as a way to turn employees' 401(k) savings into an income stream that will last retirees the rest of their lives. Interest in providing annuities to 401(k) participants seems to be picking up steam, with the Obama administration recently signaling its support for making annuities available. But it's not clear that any changes the government makes to promote the use of annuities within defined-contribution plans will have much effect. Plain and simple, participants don't seem interested in using their 401(k) savings to buy annuities, and it's not clear what companies can do to change their minds.

A recent survey by HR consultancy Hewitt Associates shows just 2% of 401(k)s offer annuities or some other retirement income solution within the plan, while 14% provide annuities as a rollover option outside the plan. In a sign of the momentum in this area, 28% of employers say they're likely to add some sort of annuity product to their plan this year. But a 2006 Employment Benefit Research Institute report indicates just 7% of employees choose to use some portion of their 401(k) savings to purchase an annuity.

Even though vendors have been working on new ways to package annuities within 401(k)s, "there's almost no utilization," says Robyn Credico, a senior defined-contribution consultant at Towers Watson. She blames that in part on people's mistrust of insurance companies, which provide annuities, and notes that the credit crisis only reinforced those concerns. There's also a perception that annuities are expensive, Credico says, as well as discomfort about surrendering a big chunk of one's savings to buy an annuity.

"It's very hard to save up what's potentially the biggest amount of money that you've ever seen and then give it up to an insurance company," she says. "Emotionally, it's challenging."

Vendors argue that more education is needed to make people realize the benefits of annuities, Credico says, noting that insurers are making an effort to make the product more appealing: "Instead of calling it annuity, they're calling it lifetime income. And they're trying to relate it to the regular insurance you buy for your house and car."

Sen. Jeff Bingaman (D-N.M.) has proposed a measure requiring plan sponsors to notify 401(k) plan participants of how much monthly annuity income their balance would buy them, which might get workers more comfortable with the idea of annuities.

But Jan Jacobson, director of retirement policy at the American Benefits Council, a trade association that represents companies on employee benefits issues, says some big companies already provide web calculators that can tell employees how much annuity income they could get with their 401(k) account balance. There's concern that if the Bingaman bill passes, the Department of Labor might come up with different assumptions and therefore a different result than employees are getting from their employer.

In another approach to making annuities more attractive, some insurers have come up with products that allow 401(k) participants to invest over time in a product that guarantees a lifetime income. HR experts note, though, that there are still some wrinkles to work out, like the additional administrative complexity they involve. And while American workers switch jobs frequently, the various income products offered inside 401(k) plans currently don't transfer between plans, Credico says, adding that the providers are working on that problem.

Tom Johnson, a senior vice president in the retirement income security business of New York Life, says the company sees annuity take-up "in the single digits," but notes that a survey shows 31% of 401(k) participants say they are "very interested" in an income that would last the rest of their lives, while almost as many say they are "moderately interested."

Johnson suggests promoting the concept of allocating some portion of a 401(k) account to an annuity when the assets are rolled into an IRA. "Because the net cash flows into rollover IRAs are more than 20 times the net cash flows into 401(k) plans, we think rollover IRAs are already the vehicle of choice for consumers consolidating retirement account balances and converting them into income.

"Our experience is that consumers value [guaranteed lifetime income] beginning in their mid-fifties and make purchases in their 60s and 70s," Johnson continued. "We would like to see best practices articulated that suggest allocating 15% to 30% of a rollover IRA portfolio to [guaranteed lifetime income]."

In January, the Obama administration said that it will be "promoting the availability of annuities and other forms of guaranteed lifetime income, which transform savings into guaranteed future income."

There has been speculation the administration might require that some portion of 401(k) savings be earmarked for an annuity. Mark Iwry, a senior adviser on retirement issues at the U.S. Treasury, co-authored a paper before he joined Treasury that suggested the use of annuities by 401(k) participants could be boosted by the kind of automatic features that have been successful in raising 401(k) enrollment. Instead of letting participants choose between a lump sum and an annuity, the paper suggests providing them with an annuity unless they specify a lump sum. After
24 months, participants would have the option of switching out of the annuity to a lump sum.

It seems unlikely, though, that the government would impose an annuity mandate. "Any kind of requirement would probably have to originate in Congress," says Jacobson.

Credico notes that a 401(k) plan is only part of an employee's financial resources. "If I have a pension plan and I have Social Security, I may not need an annuity," she says. "For you to insist I buy one is inappropriate."

Even insurers seem wary of requiring 401(k) participants to use annuities. "We opposed mandatory solutions because we are convinced by our experience the market--investment and insurance companies--can work together to achieve success," agrees New York Life's Johnson.

Last month, Treasury and the Department of Labor said they would review the rules governing 401(k) plans to see if there were ways to facilitate access to annuities. The two agencies issued a joint request for information.

There are areas where plan sponsors could use a hand, including the administrative complexities of offering annuities.

Plan sponsors also fret about the fiduciary liability involved in selecting an annuity provider. "There are some providers that may help you with the fiduciary responsibility, but you never give up all your responsibility," Credico says. She notes that the government has talked about setting up something similar to the Federal Deposit Insurance Corp. for insurers. "That may help."

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