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Including a source of guaranteed income into a 401(k) plan is becoming increasingly important, while an annuity is often misunderstood by employees or pre-retirees. Despite the benefits of a guaranteed income stream for life, not enough defined contribution (DC) plans include enough options in the plans, and not enough participants are seeking out an annuity. This dilemma is often referred to as the ‘annuity puzzle” by economists.
“The annuity puzzle is a concept that suggests retirees don’t utilize annuities at the level that would generally be considered optimal by retirement economists,” said David Blanchett, Head of Retirement Research at PGIM DC Solutions. “Retirees face challenges when it comes to spending down savings in retirement given the myriad of uncertainties that exist around market returns, longevity, etc.
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“One potential path to increasing usage of annuities would be to make them more generally available in DC plans. Therefore, I don’t know that there is an annuity puzzle in DC plans, but rather, that DC plans can help solve the annuity puzzle!”
Blanchett breaks the solution to the puzzle down into three steps:
#1: Include annuities in DC plans –Plan sponsors don’t “necessarily need to offer lifetime income products, but I think making lifetime income products more widely available would increase usage among retirees,” said Blanchett. “DC plans are where Americans do most of their retirement savings, therefore increasing access to annuities would help these workers more easily convert their savings into retirement income.”
Plan sponsors need to offer “recent innovations like fiduciary safe harbors and diverse product options,” added Blanchett.
#2: Encourage participants to allocate to annuities – “Adoption can be improved by integrating annuities into default investment options, like target-date funds, and providing clear communication and professional guidance,” said Blanchett.
“The best way to get participants to allocate to an annuity more generally is to include it in the default investment; however, this doesn’t necessarily mean the participants will activate the income benefit (or annuitize),” he said. “I think getting participants to use the annuity is going to take time, effective communication, and access to advice.”
#3: Simplify income activation – “Participants must have access to straightforward, flexible products that minimize decision points and offer liquidity to make activating lifetime income benefits easier,” said Blanchett.
Related: The differences between ‘retirement income,’ guaranteed income,’ and ‘lifetime income’
“There are a variety of potential lifetime income products an employer can make available to participants. The simplest would likely be some kind of annuity supermarket that gives participants access to annuities like single premium immediate annuities (SPIAs) and deferred income annuities (DIAs).
“SPIAs and DIAs lack flexibility and liquidity and this is where strategies with some kind of living benefit can be attractive. There are typically additional operational complexities when offering products with living benefits; however, a number of middleware solutions are being created to make this easier for plan sponsors.”
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Lynn Cavanaugh
Lynn Varacalli Cavanaugh is Senior Editor, Retirement at BenefitsPRO. Prior, she was editor-in-chief of the What's New in Benefits & Compensation newsletter. She has worked for major firms in the employee benefits space, Vanguard and Willis Towers Watson, as well as top media companies, including Condé Nast and American Media.
