Monday, February 15, 2010

Safety “Knot”

Two weeks ago, the Department of Labor and the U.S. Treasury turned to the retirement plan community for some input on how to “enhance retirement security for workers in employer-sponsored retirement plans through lifetime annuities or other arrangements that provide a stream of income after retiring.”

Now, part of what the DoL is trying to figure out (see Feds Call for Lifetime Income Product Public Comment) is why the take-up rate on annuities (technically “lifetime annuities or other arrangements that provide a stream of income after retiring”) is so dismal—not just because many see them as a superior way to ensure that “stream of income,” but because some are hoping that, if it can be made more available as a distribution option (perhaps even a default distribution option), more participants will take advantage of it.

There are good reasons for the inquiry. We all know that most participants with a non-retirement-related distributable event (such as a job termination) tend to have relatively small balances; that all too often they take that small balance as a cash distribution—and spend it (what’s left after taxes and penalties, anyway). We also know that many, perhaps most, defined contribution plans don’t provide an annuity distribution option. Not that it would likely matter, since defined benefit plan participants who, unlike their DC cousins, are frequently given that option routinely reject it in favor of a lump-sum option (when offered). Therefore, it doesn’t take much imagination to realize that merely having the option available won’t be enough to impact participant behaviors (and trust me, even as a default, when it comes to getting that distribution check, I suspect participants won’t be as pliant as they have been with other automatic design features).

Participants have, it seems, learned to distrust annuities. Stories abound of individuals who have been bamboozled by unscrupulous advisers (and sometimes by annuity providers themselves)—in terms of product, promise, and fees. While the concept of an annuity—giving your money to a firm that will, some years hence, provide you with a specific income stream—is relatively straightforward, the realities are anything but. The here-and-now money being surrendered inevitably seems larger than the promised income stream, and unless you have an actuarial bent, it’s nigh impossible to figure out how badly you’re being ripped off1—assuming that the firm you hand that money over to is still financially viable 20 years out. Moreover, the disclosures attendant with those purchases—certainly on the retail level—are enough to make you long for the brevity, simplicity, and coherence of a mutual fund prospectus. Sure, you can lose your shirt at the craps table, but at least you’ll have some fun doing it.

From an employer standpoint, the current reluctance is, IMHO, even easier to understand. First off, there are all the same issues and concerns that the participant has with regard to the complexity of the product and “disclosures” (and I use the term loosely)—and the ever-present sense that they are getting ripped off (though, at an institutional level, perhaps less so). Take all that, add to it the already-daunting obligations of a plan fiduciary, and extend those not only past employment, but potentially past the lifetime of the participant himself. While the Labor Department has made several efforts to ameliorate those concerns, they can’t really afford to let the fiduciary totally off the hook for making a prudent decision in choosing a provider/product—but let’s face it, whatever stance the DoL may take, litigators may well choose to apply a less stringent standard. However much that plan fiduciary would like to help the participant make the right choice(s), it’s hard to imagine why they would want—or be expected to want—to assume that kind of potential liability today, much less decades into the future.

So, what’s to be done? We are, in essence if not reality, talking about a structure that will allow workers to buy their own personal pension, and, IMHO, the questions that need to be answered aren’t really all that hard to understand.

People want a safe repository where their savings can be comfortably entrusted at the proper time, and from which a secure, predictable stream of lifetime income can eventually be drawn. That comfort will, in turn, require that it be relatively easy to communicate (and understand), and—like any retirement investment—that fees can be disclosed (and understood). It would be a program that, hopefully, plan sponsors can facilitate without becoming co-signers of the obligation. One, it should be said, that won’t put those savings at risk during the interim by imprudent speculation (as the private sector sometimes does) or misappropriation for other purposes (as politicians are wont to do). And one that, IMHO, remains a voluntary choice, not one imposed on participants (if you want to wipe out voluntary retirement savings, just tell people they won’t be able to get their money “out” EXCEPT as an annuity distribution).

Indeed, in my mind, the question about a retirement income solution isn’t so much about why plan sponsors have been reluctant to offer these options at present—and why even fewer participants take it—because I think that, once we give people the right kind of choice, they’ll make it.

- Nevin E. Adams, JD

The Labor Department’s request for information is online HERE

1 Another great rip-off fear: that you’ll hand over your life savings assuming that you’ll get it all back over the rest of your life, only to die prematurely and leave nothing to your heirs, is a very real concern (and one that never seems to be counterbalanced in most participants minds by the notion that you could live longer than anticipated and draw more than was put into your account.

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