Posted by Jeffrey Brown on Mar 16, 2010
Filed Under (Uncategorized)
Last month the Departments of Labor and Treasury issued a Request for Information in order to solicit public comment on ideas related to converting 401(k) account balances into annuities or other guaranteed retirement income streams. This is a topic about which I have given a lot of thought – indeed, I even wrote a paper recommending that annuities become the “default option” for distributing from 401(k) plans. (Click HERE to see the paper).
As I see it, there is a good case to be made for thinking about guaranteed lifelong income as the default distribution option. My primary motivation is to ensure that individuals have the private sector financial tools available to optimally manage their retirement portfolios in the presence of uncertainty about how long they will live. Annuities solve this problem by allow one to trade a lump sum of wealth for an income stream that will last as long as you (and possibly a spouse) live. There are mountains of academic research suggesting that annuities can make people better off by offering a higher level of sustainable consumption, insuring against longevity risk, and so on.
Enter stage right, Newt Gingrich and Peter Ferrara. In a piece on Investor Business Daily’s website (read it here), they wrote an article entitled “Class Warfare’s Next Target: 401(k) Saving.” In it, they essentially argue that treating annuities as the default distribution option is somehow a left-wing conspiracy to tax your retirement, force people to buy government bonds, and do other evil things in the name of “class warfare.” (You can also find it on the AEI webpage and a related post on the conservative blog watch.)
I am extremely puzzled by their hostility towards the general idea. But before I point out what I do not like, let me point out some valid points they raise:
First, they correctly point out one longer-term risk of a government program that starts out as optional – which is that they can, through the political process, end up paving the way toward a mandate. There is no question that mandated annuitization would be a bad thing on many levels – it would interfere with individual liberty and choice, it would effectively redistribute resources from the poor (who don’t live as long) to the rich (who tend to live longer), and so on. So they are right to be concerned about where an optional program will ultimately lead in a political environment – a point that academic economists too often overlook when thinking about optimal policy designs.
Second, I completely agree with their general dislike of the Ghilarducci proposal to invest in a guaranteed retirement account administered by the Social Security Administration. Indeed, I could write 20 blogs on all the things I dislike about this proposal, whether it be the absurdly high return that Ghilarducci proposes to guarantee at taxpayer expense (without appropriately accounting for the true economic cost) or the very idea that the under-resourced, overly-bureaucratic Social Security Administration should be expanded into an area that the private sector can run perfectly fine.
Third, I certainly cannot quibble with their general ideological distaste for policies that keep “punishing responsibility and rewarding failure.” As readers of this blog can probably tell, I am an advocate of free market capitalism, and I generally distrust over-reaching government regulation.
Given all of this, why do I support annuities as a default option? And why do I disagree with the Gingrich/Ferrara critique? Here are a few reasons. I will keep it short so this post does not grow monstrous in size, but perhaps I will return later:
Part of the goal here is to do what conservatives like me generally like – to provide people with more choice, not less. The idea is to get more plan sponsors to offer annuities as a distribution option from their 401(k) and other DC plans. Right now, few do so, and so individual participants who want annuity income are forced into the individual market where they don’t get as good of a deal (due to concerns about adverse selection, etc.)
- We already have a default distribution option from 401(k) plans – in most cases it is to take a lump-sum distribution. The question is about what type of default option makes the most sense for the most people. I think the research is pretty clear that most individuals do not have adequate sources of guaranteed retirement income, and that a product that provides guaranteed lifetime income would make them better off. A lump-sum strikes me as precisely the wrong default option for a retirement plan.
- What I favor is an optional program. As I have outlined in my proposal, people would have plenty of opportunity to take an alternative distribution if they want it. Those who (like me) place a high premium on individual liberty should take comfort in the fact that my proposal would place no restrictions on an individual’s ability to opt out of the annuity if they want.
- There is nothing in my proposal that forces people to hold treasury bonds or subject themselves to inflation risk, as implied by Gingrich and Ferrara. Indeed, I am a big advocate of inflation-indexed annuities and/or variable payout life annuities in which the lifetime payouts are linked to an underlying portfolio like those offered by TIAA CREF (disclosure: I am a Trustee for TIAA.) Plus, an annuity provides what some call a “mortality premium,” which is an extra rate of return in exchange for making the benefits life-contingent.
- Under my proposal – and under most of the serious proposals I have heard so far – the government (whether it be Social Security Administration or some other agency) would NOT be the administrator of this program. Rather, plan sponsors could contract with private sector annuity providers – and there is a nice, active, competitive market for such products.
Yes, I am a big fan of free markets. But only a fool would think that the existing 401(k) system looks like it does because of pure free market forces. The complicated system we have in place today is as much a creature of government regulation as any program we have. Indeed, the name “401(k)” itself refers to a section in the Internal Revenue Code!
As long as we are operating in a world in which government rules largely drive plan sponsor decisions about what kind of retirement plan to offer – and as long as plan design influences participant behavior – and as long as participant behavior drives how well off these participants will be when they retire – then does it not at least make sense to ensure that the basic set of rules be ones that make people’s retirement more secure rather than less? Especially if we can do it in a way that preserves individual choice?
I respect Gingrich/Ferrara’s healthy skepticism of government. But sometimes ideology can get in the way of a good idea.