Posted on 06 January 2010
By Mark Miller
Social Security and a pension–there was a time when they went together like coffee and cream. Together, they provided a guaranteed source of automatic retirement income–no management by retirees required.
According to The Urban Institute, 38 percent of private sector American workers had traditional pension plans as recently as 1980–funded and managed by employers and providing a regular lifetime check after retirement. By 2008, only 20 percent of workers had a defined benefit pension.
For the most part, defined benefit pensions have been replaced by voluntary contribution 401(k) plans, which don’t guarantee anything at retirement–as demonstrated by two wrenching bear markets over the past decade.
Now, a new form of guaranteed retirement income appears to be gaining ground. A growing number of employers are offering the option of a retirement annuity as part of their workplace plans, according to a survey by Watson Wyatt, the employee benefits consulting firm. At the same time, the Obama Administration is exploring ways to encourage employers to offer annuities through changes in federal rules governing workplace retirement benefits.
Annuities are an under-appreciated financial tool for achieving retirement security. Insurance companies sell them, and there are two basic types–income and deferred. Deferred annuities are similar to mutual fund retirement vehicles, in that you’re investing money with the aim of a future return–although the fees can be very high.
With an income annuity, the goal is retirement income. The plain vanilla product is called a single premium income annuity (SPIA), and the proposition is fairly simple. At some point after you retire, you make a payment to an insurance company, which in turn promises to send you a regular check from a date certain. In most cases, the payments continue as long as you live.
The SPIA hasn’t been a very popular financial tool for retirement. One reason is the overwhelming urge people seem to have to choose lump sum payments over an income annuity stream; even in cases where employer-sponsored retirement plans offer the choice of a lifetime annuity or a lump sum payment, most choose the lump sum. Very often, people just aren’t comfortable giving up control over a fairly large sum of money to an insurance company.
But the Watson Wyatt survey found that 22 percent of employers that sponsor defined contributions plans already are offering an annuity as a distribution option–and that another 10 percent are considering adding it. At the same time, financial services companies have been rolling out new annuity offerings tailored for workplace retirement programs.
The employer-based plans include an array of deferred and income annuity products. “The common thread is that they all have a lifetime income at retirement feature,” says Mark Warshawsky, Watson Wyatt’s director of retirement research.
While insurance companies are very happy to sell you an annuity on your own, employer-based plans may offer some advantages, Warshawsky says. “An employer plan generally can negotiate lower fees and they have a fiduciary obligation to find a low-risk plan.”
But workplace annuities won’t be right for everyone–and they may not always offer the best deal. For example, individual market annuities are more expensive for women than for men, because men tend to die at younger ages. But workplace plans must be gender neutral in their pricing; that means men may pay a higher averaged price than they would in the individual market.
“There are plusses and minuses, and you really need a sharp pencil to figure it out,” Warshawsky says.
Workplace annuity programs could get a further boost soon from the Obama Administration, which is considering ways to improve guaranteed sources of retirement income.
Last year, the administration recruited retirement security expert Mark Iwry to become a senior adviser to Treasury Secretary Timothy Geithner focused on benefits reform. Iwry was a key retirement benefits official in the Clinton Administration, and advised the Obama campaign on retirement policy. Before joining Treasury, he was a principal of the Retirement Security Project, a non-partisan group that has developed a number of innovative proposals aimed at simplification of retirement benefits.
In public presentations last year, Iwry described some ideas under development for employer-based defined contribution plans–for instance, converting a portion of a retiree’s 401(k) into a monthly income payment for a two-year default period unless the employee opts out.
Resources: Learn more about annuities.