Pushing back against annuities in 401(k)s

The mounting calls from lawmakers, regulators, and even the Government Accountability Office for more annuities in 401(k) plans is getting pushback from prominent retirement economists.

In testimony before the ERISA Advisory Committee last month, Teresa Ghilarducci, the Irene and Bernard L. Schwartz Professor of Economics and Policy Analysis at The New School for Social Research, claimed private-sector annuity products were in a state of market failure.

“Allowing annuity products into 401(k) s and IRAs will not likely solve a significant portion of the retirement crises and may cause even more problems and predation,” said Ghilarducci in written testimony.

She and other economists on the Bipartisan Policy Center’s Commission on Retirement Security have previously examined the role annuities could potentially play in creating a guaranteed lifetime income stream for retirees.

BPC’s Commission looked at the “pitfalls and potentials” of annuities for 401(k) savers.

“We were concerned about the pitfalls, and therefore were not excited about the potential,” testified Ghilarducci, who counted high fees, product complexity, and the “insecurity” of commercial annuity products as strikes against facilitating wider access to the products in defined contribution plans.

Moreover, the limited savings of most plan participants and IRA owners would translate into a paltry monthly lifetime benefit for most, she said.

“At the very least we were concerned about the ‘junk’ that might end up in the plans,” said Ghilarducci of the Commission’s work.

Benefits for few

Ghilarducci is a long-time critic of the country’s private-sector retirement system. She co-authored “Rescuing Retirement” with Hamilton (“Tony”)  James, Executive Vice Chairman of Blackstone. They lay out a plan for mandatory retirement savings accounts, to which employers and employees would contribute 1.5 percent of annual salaries in government-backed accounts. Savings would be paid out in annuities.

Her testimony before the ERISA Advisory Committee reads as a not-so-tacit rebuke of insurance companies.

While surveys of retirement savers show high levels of interest in guaranteed income products, take-up rates are low.

“Sadly, we are aware, most workers want a fixed annuity. But industry wants to sell variable annuities,” writes Ghilarducci.

“Fees for variable are triple of fixed. And the insurer always wins – they have to, they have a duty to shareholders. An anonymous expert and practitioner told me ‘Market up, insurer gets a big cut. Market down, insurer cuts return to payee. Surrender charges if try to cancel’,” she added.

Low purchase rates have created a market failure in annuities, thinks Ghilarducci. A subsequent lack of assets to adequately pool risk, adverse selection from an aging population, and insurance companies’ profit requirements all make annuities too expensive, she said.

Creating safe harbors that would allow plan sponsors to more readily offer annuities to 401(k) plans would not improve the products’ lack of pooling, argues Ghilarducci.

Of the 28 million near-retirees in the workforce, one-third have no retirement savings. The median account balance in the segment is $15,000.

For those that do have retirement account balances, the median amount is $92,000. Annuitizing that lump sum at age 65 would create $7,000 per year in guaranteed income, which would not be enough income replacement to maintain pre-retirement living standards.

Her point to the Advisory Committee: The number of preretirees impacted if annuities were available in defined contribution plans would be “quite small.”

A better option for Labor and regulators

Rather than focus on updated safe harbors for annuities in defined contribution plans, Ghilarducci wants the Employee Benefits Security Administration to help employers encourage workers to delay claiming Social Security.

Workers with retirement savings in 401(k) plans would be better served spending the assets down to delay claiming Social Security than they would buying an annuity, she argues.

“If the median account holder could hang on and spend down the $92,000 and delay collecting Social Security from 62 to 70 instead of annuitizing, that person would have $10,000 more per year from Social Security– starting at 70–and the annuity would be indexed for inflation,” says Ghilarducci.

She views employers as genuine in their concern over workers’ retirement security but also claims employers view the existing defined contribution system as inadequate.

Helping craft language for employers that encourages delayed Social Security claims would be welcomed by employers, and ultimately more productive for advancing retirement security than annuities in 401(k)s, says Ghilarducci.

“I conclude that the commercial annuity market just can’t solve the lifetime income problem for most people even if the products were in the DC and IRA universe,” writes Ghilarducci.