Academics have long agonized over something they call the annuitization puzzle.
Simply stated, the thing academics can’t quite understand is the
reluctance of American workers to embrace annuities as a distribution
option for their retirement savings. Some of that is because they assume
workers are “rational” when it comes to complex financial decisions,
specifically because “rational choice theory” suggests that at the onset
of retirement, individuals will be drawn to annuities because they
provide a steady stream of income and address the risk of outliving
Compounding, if not contributing to that belief, are surveys – albeit surveys generally published,
if not conducted by, annuity providers (or supporters) that
consistently find support from participants for the notion of reporting
benefits as a monthly payout sum, if not the notion of providing a
retirement income option. And yet, despite those assertions, in the
“real” world where participants actually have the option to choose
between lump sums and annuity payments, they pretty consistently choose the former.
That said, a study
by the non-partisan Employee Benefit Research Institute (EBRI) also
supports the notion that plan design matters, and matters to a large
extent, in those annuitization decisions.
Over the years, a number of explanations have been put forth to
explain this reluctance: the fear of losing control of finances; a
desire to leave something to heirs; discomfort with entrusting so much
to a single insurer; concern about fees; the difficulty of understanding
a complex financial product; or simple risk aversion. All have been
studied, acknowledged and, in many cases, addressed, both in education
and in product design, with little impact on take-up rates.
Yet today the annuity “puzzle” remains largely unsolved. And, amid growing concerns about
workers outliving their retirement savings, a key question – both as a
matter of national retirement policy and understanding the potential
role of plan design and education in influencing individual
decision-making – is how many retiring workers actually choose to take a
stream of lifetime income, versus opting for a lump sum.
Some of that surely can be attributed to the lack of availability.
Even today, industry surveys indicate that only about half of defined
contribution plans provide an option for participants to establish a
systematic series of periodic payments, much less an annuity or other
in-plan retirement income option. Indeed, I’ve never met a plan sponsor
who felt that the official guidance on offering in-plan retirement
income options was “enough.”
Enter the bipartisan Retirement Enhancement and Security Act (RESA),
which includes a provision to require lifetime disclosures – and while
its prospects seem bright, it remains only a prospect. Closer to a
current reality is Tax Reform 2.0, but the retirement component of the legislation approved by the House Ways and Means Committee on Sept. 13 did not address the subject – or at least didn’t until the Chairman Kevin Brady introduced a Managers’ Amendment that largely, if not completely, mirrors RESA’s.
That 8-page addition outlines a “fiduciary safe harbor” for the
selection of a lifetime income provider, which, as its name suggests,
binds the liability to a consideration “at the time of the selection”
that the insurer is financially capable of satisfying its obligations
under the guaranteed retirement income contract. It also clarifies that
there is no requirement to select the lowest cost contract, and that a
fiduciary “may consider the value of a contract, including features and
benefits of the contract and attributes of the insurer” in making its
determination. Moreover, there is language that notes that “nothing in
the preceding sentence shall be construed to require the fiduciary to
review the appropriateness of a selection after the purchase of a
contract for a participant or beneficiary.”
At this point, it’s impossible to say whether this legislation will
be signed into law, much less whether it will prove sufficient to
assuage the concerns that have continued to give most plan sponsors
pause in adopting this feature.
A couple of things seem clear, however. First, as long as plan
fiduciaries continue to feel vulnerable to a generation of potential
liability for provider selection beyond the initial selection, they
aren’t likely to provide the option.
And participants who are not given a lifetime income choice as a distribution option will surely not (be able to) take it.
- Nevin E. Adams, JD
See 5 Reasons Why More Plans Don’t Offer Retirement Income Options