Participants in 401(k) plans are likely to see substantial
changes if Congress passes a package of modifications to the U.S. retirement
system.
Chief among them is a greater role in 401(k) plans for
annuities—insurance contracts under which workers pay an insurer a lump sum in
return for a lifetime income. While traditional pension plans typically provide
such a feature, it is largely absent from 401(k)-style accounts.
“We have made a lot of progress in helping people save with
401(k)s,” said Shai Akabas, director of economic policy for the nonprofit
Bipartisan Policy Center in Washington, D.C., whose research includes topics
related to retirement security. “The next step is to help people turn their
savings into lifetime income.”
The proposals
under consideration, which also include measures to encourage small companies
to offer retirement plans, could face obstacles moving through a divided
Congress in an election year. But if they pass, they would amount to the most
significant alterations to 401(k) plans since 2006, when Congress made it
easier for employers to enroll workers automatically.
Here’s what you need to know about the contemplated changes
that involve annuities:
1) Why
do policy makers want to encourage 401(k)s to offer annuities?
While traditional pensions commonly feature annuities to
help to workers with the complex task of making a nest egg last a lifetime,
only about 9% of the 401(k)-style plans Vanguard Group administers do the same.
With an annuity, the insurer is typically on the hook to
continue monthly or annual payments for as long as the worker lives, providing
the worker with protection against outliving his money.
Annuities generally have higher fees than mutual funds. But
“401(k) plans can negotiate with insurance companies to purchase annuities at
group or institutional prices to make them available to participants at reduced
cost,” said Mark Iwry, who oversaw retirement policy in the U.S. Treasury
Department during the Clinton and Obama administrations.
2) How
would the bills in Congress encourage 401(k) plans to offer annuities?
Annuities aren’t often used in 401(k) plans, in part
because employers worry that if they pick an insurance company that ends up
going bust, the 401(k) participants will sue the employer.
The bills give employers that follow certain procedures
some protection from future lawsuits. Plan sponsors would still have to
evaluate an annuity’s features and fees to ensure they are appropriate and
reasonable, said Mr. Akabas.
The bills also would allow employees to roll over an
annuity from a 401(k) plan to an individual retirement account if the employer
decides to stop offering the annuity.
And it would require companies, at least once a year on
account statements, to provide participants with an estimate of the monthly
income their current balance could generate with an annuity.
3) Am
I likely to see an annuity in my plan any time soon?
Just as automatic enrollment in 401(k) plans gained
popularity gradually since Treasury sanctioned its use 20 years ago, Mr. Iwry
anticipates a moderate uptick in annuities immediately after the bills’
enactment and a continued gradual expansion over time.
Currently, 68% of the 401(k)-style plans Alight Solutions
LLC administers feature automatic enrollment, up from 14% in 2001.
4)
What type of annuities are 401(k) plans likely to offer?
The proposed law would leave it up to employers to decide.
Some annuities are fixed, which simply means they pay an amount that’s
established at the outset. Others have elements of variable annuities, with a
value that fluctuates with an underlying investment portfolio, and a rider that
protects against stock-market losses and guarantees a minimum paycheck for
life.
5)
Do I need an annuity?
Annuities have some drawbacks. For example, they offer less
potential for outsize gains than stocks or funds. And once you hand over your
money to an insurer, you may not be able to leave it to heirs or get it back
without paying surrender charges or sacrificing at least some of the guarantee
you have paid for.
But for those worried about the risks associated with
ensuring a paycheck for life, annuities may have an appeal.
How much should you consider putting into an annuity? If
Social Security plus any pension you receive won’t cover your essential monthly
expenses, many economists recommend buying an annuity for an amount that
bridges the gap.
One way to hedge your bets is to buy annuities in
increments over time. Proponents say that by doing so you will reduce the odds
of buying at an inopportune time. For instance, when interest rates are low, as
is the case today, insurers offer skimpier payouts because they stand to earn
less on the corporate and government bonds that back their payments.
Another reason to stagger your purchases: It gives you some
flexibility to adjust your annuity purchases if your circumstances change.
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