Transforming 401(k) plans into DB plans

Employee Benefit News

By Lydell C. Bridgeford

April 5, 2010In the quest to make 401(k) plans look more like defined benefit plans, government officials are reaching out to employers and other stakeholders in the retirement plan industry for advice on offering annuities through defined contribution plans.

In February, the Departments of Labor and Treasury issued a request for information (RFI) to help federal regulators map out a course of action to improve Americans' retirement savings by purchasing lifetime income options, which include annuities. ...

The RFI hopes to solicit comments on topics that include:

* The advantages and disadvantages of distributing benefits as a lifetime stream of income both for workers and employers, and why lump sum distributions are chosen more often than a lifetime income option.

* Developments in the marketplace that relate to annuities and other lifetime income options.

"[The RFI] initiative is particularly important given the shift from defined benefit plans that offer employees lifetime annuities to 401(k) and other defined contribution plans that typically distribute retirement savings in a lump sum payment," says Phyllis C. Borzi, assistant secretary for the DOL's Employee Benefits Security Administration. Some retirement-income experts also contend that large swings in the stock market also have forced policymakers to rethink how the nation saves for retirement.

'Clearing the air'

The outcome of the government's request for public comments on lifetime income options will probably find some low-hanging fruit of the regulatory side to providing annuities within DC plans, says Edward Ferrigno, vice president of Washington affairs at the Profit Sharing/401(k) Council of America.

PSCA's latest research shows that about 20% of DC plan and profit-sharing sponsors offer an annuity option.

Still, retirement-income analysts observe that some employers are reluctant to offer annuities within their DC plans because of a lack of demand among participants and the complexity of the product in plan administration. …

A new landscape

Americans are living longer, and many will outlive their retirement assets. Annuities, in part, offer retirees the opportunity to exchange accumulated wealth for a lifetime stream of guaranteed income.

DC plans gradually are becoming the primary source for retirement income for many U.S. workers, given that traditional pension plans are slowly fading away, explains Charlie Nelson, president of Great-West Retirement Services. …

DOL hopes to figure out ways in which people don't run out of money while they are in retirement, says Karen Friedman, executive vice president and policy director of the Pension Rights Center, a Washington, D.C.-based advocacy group for workers and retirees.

Providing lifetime income options is a good idea, considering that "we are facing a retirement-income crisis in this country where people are not saving enough for retirement and millions of people are not going to have enough retirement income," Friedman says.

… "Even before the recession, the median account balance in a 401(k) plan was $25,000 and $40,000 for those nearing retirement, which is really not a lot of money," [Friedman notes].

Therefore, individuals with low 401(k) account balances will be reluctant to hand over those funds to a financial institution for an annuity, Friedman asserts. …

Think again

Jane White, president of Retirement Solutions, LLC, sees federal regulators call for a national discussion on lifetime income options as the brainchild of some key players in the Obama Administration.

The concept of "automatic annuitization is the product of the Retirement Security Project, launched by the Hamilton Project, which is part of the Brookings Institution. That project was run by Peter Orszag, who now runs Obama's Office of Management and Budget and Mark Iwry, who is now deputy assistant at the Department of Treasury," explains White.

"In the same fashion that automatically enrolling employees in 401(k) plans is seen a way of combating inertia, automatically annuitizing their account balances at retirement age is viewed as a paternalistic way of preventing them from shooting themselves in the foot by cashing out of vested balances and spending the money foolishly," White adds.

Many Americans are unable to retire because they only have a 401(k) plan. "Because of the puny 3% employer match, the only Americans who can afford to retire are ones that started saving at age 25," White notes. The rule of thumb for retirement readiness, created by pension actuaries, is that you need to have saved the equivalent of 10 times your final pay - or your salary right before retirement - in order to be able to afford to retire.

"The typical 65-year-old has a median income of $64,000 and savings of only $110,000. Therefore, retirement is not possible and it is irresponsible to sell someone an annuity when it can't make an empty nest egg full," White explains. For example, a 65-year-old with a $100,000 annuity who withdraws 4% a year will get $8,000 a year, or about $650 a month.

White asserts that such an amount will not adequately cover the living expenses for most Boomers, especially those who are still paying off their mortgages and footing the college tuition their children.

More importantly, annuities are expensive ways to create retirement income. White notes that "mutual fund industry has 'managed payout' funds that accomplish the same thing as an annuity at a lower cost." Besides, the only guarantee that the annuity purchaser receives is that the individual gets back the money he or she puts into it, plus any returns that you earned, White asserts. "You will very likely get this promise from a mutual fund as well at a lower cost."

Current hurdles

Employers with DC plans will certainly drill down on the fiduciary liability attached to providing an annuity in a DC plan, says Jan Jacobson, senior counsel of retirement policy at the American Benefits Council, a business association that represents private-sector employers.

"If you look at it from the point of view that you pay out a lump-sum, then whatever liability the employer has is over. The money is removed from the plan and it goes to the plan participant," Jacobson explains. Yet with an annuity, "it's conceivable that participants might come back 20 years later if the annuity provider goes under."

Jacobson also hopes the RFI process will yield clearer and straightforward guidance on some current practices on annuities in DC plans. Presently, DC plan sponsors "are a little bit confused on what the criteria is in selecting annuities to the plan, especially on how to determine the safest available annuities," Jacobson says. … L.C.B.