Many baby boomers will be retiring on savings, without the secure pension checks that their parents enjoyed. As more boomers embark on this adventure, it is becoming increasingly clear that getting through retirement by living off investments is too difficult and unpredictable for most of us.
This uncomfortable conclusion is driving the government, employers and particularly insurers to come up with an alternative -- something that works a lot like an old-fashioned defined benefit pension plan.
So far, the likeliest candidate is an annuity within a 401(k) plan. Last September, the U.S. Department of Labor's Employee Benefits Security Administration and the Treasury Department sponsored a hearing on these lifetime income options. At the end of the sessions, it seemed clear that annuities within 401(k)s were a concept that employers, the government and -- especially insurance companies -- were happy to embrace.
Enthusiasm doesn't trickle down
There is just one big problem. Most employees are somewhere between stone cold and lukewarm to the idea. The Department of Labor asked for public responses to its proposal to approve annuities as "safe harbor" investments within retirement plans. The average response among the 800 received wasn't too far away from this one by Ross L. Webster, a retired Marine from North Carolina:
"Do you think Americans are IDIOTS? You would like to take our hard-earned money in IRAs and 401(k)s that WE CONTROL and promise a lifetime annuity that we can trust YOU to pay in the future?"
Despite public skepticism, some employers and retirement plan sponsors are already offering annuities or annuity-like products in 401(k)s. Prudential Financial says it has about 6,000 401(k) plans that have made its Income Flex plan an option for its employees. Phil Waldeck, a vice president who leads Prudential's pension plan risk management, says the key is to provide a plan that guarantees a minimum payout while providing participants with potential increases if the market is good and their savings grow.
New and improved annuities
"When you say annuity, people think single balance that converts into a fixed-income payout that is flat and irrevocable. People don't want that. What we're offering is a variable solution with a minimum withdrawal benefit with upside potential. That is starting to be embraced," Waldeck says.
Most participants in the Prudential plan, Waldeck says, choose to move their money into the accumulation phase of the Income Flex plan when they are around age 50, the youngest age at which they can secure a guaranteed minimum amount. That gives them time to increase contributions so they can lock in as high a payment as possible at retirement. Once they move their money to the plan, participants know the minimum that they will receive monthly no matter what happens to the market as they approach retirement.
When they reach retirement, if their nest egg has grown significantly, plan participants have the opportunity at specific times to revise the guaranteed payment amount upward. But if the economy falters during the accumulation phase like it did in 2008, they can be confident that their monthly checks will continue to be no lower than the minimum they had been guaranteed.
Other models for turning a 401(k) into an annuity operate outside participating plans. For instance, Hueler Investment Services offers its plan sponsors an annuity purchase platform. Employees of its member companies can post their information on the platform, including their age and amount of savings, and annuity providers bid.
Director Kelli Hueler says her company's program forces insurers to operate on a level playing field that is transparent and displays costs upfront. It also relieves employers of the concern that they could be considered plan fiduciaries and held responsible for bad investments or failures.
"Participants can put any amount of money there. If they are concerned about outliving their assets, there are plans that will help them. If they are afraid of dying early, we can structure the annuity differently. We put employees in the driver's seat," Hueler says.
Hueler adds that no matter how good she thinks this option is, it can be a tough sell because for so long annuities had had a deservedly poor reputation. "So many people have had bad experiences being sold something they didn't need or they were offered something anybody would walk away from," she says.
Needs federal guarantee
Alicia Munnell, director of the Center for Retirement Research at Boston College, says annuities within 401(k) plans won't be widely accepted until the federal government offers some kind of reinsurance. At this point, every state provides some sort of annuity guarantee. Nearly all max out at either $100,000 or $300,000. If you have more in an annuity, you risk losing it if an insurer goes belly up.
Munnell believes that's not good enough. "Especially in the wake of the financial crisis, people are skeptical about the health of insurance companies. For this to work, the government has to say it will insure that your insurance company will be there to pay out the full amount of the annuity."
Checklist of questions to ask
If you are offered one of these plans, be sure to ask these questions, says Thomas M. White, a partner who specializes in employee benefits at the Chicago law office of Arnstein & Lehr.
* What insurance company is guaranteeing this plan and what happens if that company can no longer offer the plan?
* How are the annuity's assets invested? If they are invested in a series of funds, how are the funds selected? How diversified are they?
* What are the costs and can they be increased in the future?
* Can you borrow against the plan in an emergency?
* What happens if you change jobs? Will the annuity contract be terminated? Will there be a surrender fee, and who will pay it? (Portability -- or lack of it -- could be a big problem with these plans.)
* What if I change my mind about the plan before I retire? Can I move my money to some other investment alternative within the plan?
White says this last question is particularly relevant because an annuity that seems appropriate at age 50 may not be the right choice 15 years later.
As always, the devil is in the details. Don't take anyone's word for how an annuity or a lifetime income option works in your retirement plan. Get benefits information in writing, and if you don't understand it, get an explanation in writing. It's best if you corroborate the information with the plan administrator and the plan provider to ensure your understanding of this complicated product.