We Need a New Retirement System

Filed Under (Health Care, Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Oct 20, 2009

The past year has not been good for 401(k)s and other retirement plans.  Among many implications of the financial crisis and deep recession, we have seen the dramatic, correlated losses across nearly every major asset class underscore the fragility of a 401(k) system that is focused predominantly on wealth accumulation rather than secure retirement income.  In essence, the 401(k) system was exposed for what it truly is – a promising supplemental savings plan, but an inadequate vehicle for ensuring a secure retirement.  

 

I’m not alone in this view.  I spend much of my time interacting with people who specialize in thinking about retirement income security – academic researchers, policymakers on both sides of the political aisle, insurance companies, financial advisors, consultants and consumers.  Over the past 12 months I have noticed a striking degree of commonality in their thinking around the fact that we need a better retirement system in the U.S.  This is not to say there are not still important areas of disagreement – for example, I find proposals to increase Social Security benefits, to return to a defined benefit system, and/or to have the government guarantee retirement income to be a combination of naive, reckless and fiscally irresponsible.  But when it comes to the future of private sector retirement plans, I believe there are a number of common themes emerging that make very good sense.

 

Yesterday, I had the opportunity to speak at the annual conference of the American Council of Life Insurers (www.acli.com) about my proposal for encouraging plan sponsors to use guaranteed lifetime income products as the default distribution option.  Before my session, I had the privilege of hearing Dr. Roger Ferguson, President and CEO of TIAA-CREF – one of the largest providers of retirement income in the world – speak on this issue.  (In the interest of full disclosure, I should note that I am a trustee of TIAA). 

 

Dr. Ferguson outlined 5 areas that need improvement in our system.  (I should note that I am paraphrasing here and including some of my own thoughts – so please do not interpret this as an exact representation of his remarks!)

 

  1. We need to return to a focus on providing guaranteed income.  During the shift from Defined Benefit (DB) pension plans to Defined Contribution (DC) pension plans like the 401(k) and 403(b), we somehow lost sight of the fact that the point of saving for retirement is to provide income security.  We need to get the focus back on annuitized, lifetime income.  This does not mean a return to the old style DB systems.  It does mean looking for innovative ways to convert 401(k) and 403(b) wealth into income before, during, and after retirement.
  2. We need to broaden coverage.  Millions of households do not have access to any employer sponsored retirement plan.  Somehow, someway, we need to fix this.  While it is true that individuals can save on their own, the evidence is overwhelming that “employers matter” in promoting saving.  Social Security alone is sufficient to replace adequate income for only a minority of households.  Indeed, given the poor fiscal trajectory of the program, the rising normal retirement age that will reduce benefits for those who claim at earlier ages, and rising Medicare premiums, its adequacy will only diminish further.    
  3. We need to ensure that individuals are broadly diversified.  I, personally, would love to see us put together individualized retirement plans that include a life cycle portfolio trajectory that gradually converts into annuitized income the closer one gets to retirement.  The investment options need to include not just stocks and bonds, but also real estate and other asset classes.  
  4. We need to ensure that individuals have access to good information and advice.  Our current regulatory structure – designed to protect consumers from tainted advice by those who might have a conflict of interest – has had the unfortunate effect of making plan sponsors go through a torturous and administratively complex route to provide good advice to participants.  We need to find sensible ways to streamline this process. 
  5. We need to provide vehicles for individuals to be able to save for retiree health care expenses.  Health Savings Accounts and other similar tools have a useful role to play here.

 

To get there from here, we do need some regulatory and policy changes.  I suspect that we may see this discussion rise closer to the top of the agenda after health care reform is behind us …

So you don’t know how long you will live? Perhaps its time for an “auto-annuity”

Filed Under (Retirement Policy) by Jeffrey Brown on Sep 14, 2009

I don’t know about you, but I have no idea how long I will live.  In most ways, this is a blessing – given how much I like to quantify things, I don’t think I could help myself from starting the grand count-down if I knew my death date for certain.  But in at least one respect – financial planning for retirement – this uncertainty is a real nuisance. 

Fortunately, there are financial products – known by the unsexy name of “life annuities” – that help solve this problem by converting  wealth into a stream of income that will last as long as you do.   There is plenty of research out there showing why annuitization can improve individual well-being by providing a higher level of consumption in retirement.  The problem is that most 401(k) plan sponsors don’t offer them in their plans, and thus most retirees or soon-to-be-retirees don’t have the option to convert their wealth into a guaranteed income stream.

Last Friday, I presented a new policy proposal at a conference sponsored by the American Council of Life Insurers, the AARP, the American Benefits Council, and WISER (apologies if I missed any sponsors!)  The gist of the proposal is to encourage 401(k) and 403(b) plan sponsors to adopt life annuities as the default distribution option from their plans.  The policy steps suggested to encourage it include fiduciary relief and the easing of some administrative burdens associated with qualified joint and survivor annuity rules.  If I may say so myself, the proposal was very well received – including by officials at Treasury, Labor and most of the Congressional staffers present.

Using “automatic enrollment” has proven very successful at increasing 401(k) participation rates, and I believe that “automatic annuitization” could help do the same for increasing annuitization in the payout phase.  This seems a worthwhile goal.  After all, saving assets is not enough to ensure retirement security – you also need a way to ensure that you have enough to live on no matter how long you live. 

I know that this will not make the most scintillating reading for the masses, but you might want to check out the paper anyway.  Whether or not this proposal is ever enacted, I am pretty confident that the future of private sector retirement plans in this country is going to include a greater role for annuitization.  So you may as well start learning about it now … here is the link to the paper.