Transcript ec25b02f519b4538b50c805c8c14ce97JeffBrownREADONLY

Automatic Lifetime Income as a
Path to Retirement Income Security
Jeffrey R. Brown
William G. Karnes Professor of Finance
and Director, Center for Business and Public Policy
University of Illinois at Urbana-Champaign
Associate Director, Retirement Research Center
and Research Associate
National Bureau of Economic Research
[email protected]
Retirement Income Security as a Goal
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The DC / 401(k) system has systematically
emphasized wealth accumulation
Having tools to convert wealth into guaranteed
lifelong income is equally important for retirement
income security
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Large economics literature on the benefits of annuities
Unfortunately, annuities have been largely ignored in plan
design: only one in five 401(k) plans offer annuities
This paper argues that it is time to encourage
income security via “auto annuitization”
The Proposal
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Congress should encourage plan sponsors to use
life annuities as the default distribution option
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Issues that I will address today:
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What are the objectives of an auto-annuitization program?
How might public policy encourage this outcome?
How would auto-annuitization work?
Note: In addition to providing more detail on these questions, the
paper discusses why such a policy is needed, reviews the literature
on defaults and annuitization, and answers a number of more
specific design questions
Objectives of Auto Annuity Program
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Make annuities available to DC plan
participants
“Change the conversation”
Preserve individual choice
Keep it simple, while encouraging
innovation
Avoid irreversible participant mistakes
Minimize the burden for plan sponsors
Suggested Policymaker Actions
Provide default annuity fiduciary relief
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Plan sponsors who adopt auto-annuitization should receive fiduciary
relief similar to that offered under QDIA rules
With sufficient notice and effective opportunity to elect otherwise, the
participant – and not the plan sponsor – would be deemed to have
selected the annuity
Illustrate DC benefits as annuity payments
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Research has found that consumers find annuities more attractive
when presented in a “consumption” frame rather than in an
“investment” frame
Content requirements under ERISA quarterly benefit statement rules
should be expanded to include an illustration of monthly income
Provide QJSA administration relief
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These rules add complexity and liabilities to plan sponsors that are
most easily avoided by excluding annuities
Change 1: Modify ERISA to allow plan sponsors to shift QJSA
administration and liabilities to an annuity administrator
Change 2: Modify ERISA to permit greater use of electronic means of
administering the QJSA rules
How Design the Auto Annuity Plan?
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Triggered upon request by employee for nonhardship withdrawal
At time of request, the account is divided 50/50 into:
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“Cash Account” and
“Annuity Account”
Annuity account (if not already in annuitized form)
would be converted to an annuity, including:
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Immediate life annuity, OR
At least 20% of the annuity account used to purchase the
first of five “laddered annuities” over 5 years
How Design the Auto Annuity Plan?
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If more than 25% of annuity account (1/8 of total DC
balance) is annuitized in any 6-month period, then
the annuity contract would be subject to a “trial
period” of 3 to 24 months.
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During this period, annuitant may seek a refund of the
premium minus the value of payments already received.
Note: The auto annuity program proposed by the
Retirement Security Project (Gale, et al) would qualify
The participant must be able to opt out of the
default. In the case of a married participant, the
spouse must provide consent.
How Design the Auto Annuity Plan?
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The default annuity must be joint-and-full survivor for
married couples, or single life annuity for single
individuals. No credit given for non-life-contingent
features (e.g., period certain, refund options, etc.)
The default annuity must be escalating at rate of 25% annually, OR indexed for inflation
Plan sponsors would be permitted to impose a
minimum “annuity account” size of no greater than
$20,000
How Design the Auto Annuity Plan?
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Credit for “in-plan” annuities:
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For plans that enter participants into deferred annuity
contracts during the accumulation phase, the actuarial
value of the life-contingent portion would “count” toward the
minimum annuitization requirement
Meant to include / encourage a number of innovative
approaches for incorporating income into the accumulation
phase, for example:
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Lifecycle funds that gradually convert into annuities
Plans that place employer match into annuity contracts
Deferred life annuity contracts as an alternative to fixed
income investment options
Example 1
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Gale, Iwry, John and Walker (2008)
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Individuals defaulted into 2-year “trial income
product.”
Unless individual opts out, she would receive 24
months of payment.
At end of the trial, the individual can then choose
alternative distribution option or be defaulted into
permanent annuitization.
Example 2
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Laddered annuitization
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Convert 1/5 of “annuity account” (1/10 of total
account) into immediate annuity.
On each of 4 subsequent anniversary date, an
additional 1/n of the account would be annuitized
(where n = 5 minus number of contracts already
purchased).
Individual can opt out at any time.
Example 3
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In-plan annuity examples
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Using deferred life annuities as an alternative to
fixed income vehicles
Directing employer match into deferred payout
annuities
Investment allocation gradually phased into
annuities as one approaches retirement
Many, many other approaches
Some Questions and Answers …
Question: Why do we need policy intervention?
Answer: We are stuck in a “bad equilibrium.” Plan
sponsors won’t do it voluntarily because (i) it
exposes them to fiduciary risk, and (ii) employees
are not asking for it.
Employees are not asking for it, in part, because (i)
the DC plan “culture” does not emphasize it, and
(ii) the lack of an annuity option means they don’t
have a reason to educate themselves about it.
Some Questions and Answers …
Question: Why not make it part of plan qualification
requirements?
Answer: Ultimately, this may be desirable. But – so far
–we have limited experience and limited empirical
evidence to be fully confident of the effect of these
provisions on plan sponsor and participant
behavior. Encouraging plan sponsors to do it
voluntarily will provide experience, data and
knowledge.
Some Questions and Answers …
Question: Isn’t Social Security enough?
Answer: While SS replacement rates average
around 42%, they are higher for lower
income HHs, and for these HHs, some
researchers have suggested that SS may
be sufficient. But for most HHs, Social
Security is not adequate to maintain preretirement income levels.
Some Questions and Answers …
Question: Why Would the Default Apply to Only Half
of the Account?
Answer: Retirees face a mix of risks – some (e.g.,
longevity risk) best addressed by guaranteed
income, while others (e.g., unexpected one-time
expenses) are better addressed by a buffer stock
of financial wealth. Our models are not sufficiently
well developed to precisely estimate the optimal %
annuitized, especially given heterogeneity of
preferences, non-DC wealth, etc.
Some Questions and Answers …
Question: Why a Joint and Full Survivor
Annuity?
Answer: Cost of maintaining living standard for
survivor is less than for couple. But many
widows suffer significant drops upon death
of spouse.
Note that 100% of “annuity account” = 50%
of total DC balance, and it is this roughly
akin to 50% QJSA rule for DB plans.
Some Questions and Answers …
Question: Why an Escalating or Indexed
Annuity?
Answer: It is important to have adequate
income at advanced ages. For someone
retiring at 65, an annual average inflation
rate of 3% will cut their real income in half
by age 89.
Some Questions and Answers …
Question: Is the Opt-out Requirement Unduly
Burdensome?
Answer: Allow it to be done electronically.
Some evidence suggests even current
approach is not unduly burdensome: in a
study by Mottola & Utkus (2007) of two
large DB plans, 75% of married annuitants
were able to opt-out of annuity.
Some Questions and Answers …
Question: How Should Small Accounts be
Treated?
Answer: If small account means limited
resources, annuitization may be even more
important! However, due to fixed costs of
administering annuity contracts, most
providers require minimum initial premium.
This proposal suggests $20,000 in the
annuity account as a reasonable cut-off.
Some Questions and Answers …
Question: How Should In-Plan Annuity Options
be Treated?
Answer: the actuarial value of any future
annuity stream should be treated as if it is
part of the “annuity account.” In essence,
the life contingent portion of any such inplan options will “count.”
Some Questions and Answers …
Question: When Should the Default Begin?
Answer: Given heterogeneity of participants, the most
sensible approach is to trigger this upon the
participant’s first request. In practice, this will be
after age 59½ or after separation from service if
the separation occurs during/after calendar year in
which employee reaches age 55. It will need to be
integrated with required minimum distribution
(RMD) rules.
Some Questions and Answers …
Question: Why Not IRAs?
Answer: The rationale clearly extends to IRAs.
But given the important role played by
employers in plan design, it makes sense to
start with employer sponsored plans.
Because the auto-annuity is a default, and
not a requirement, it is unlikely that
individuals will roll into an IRA simply to
avoid a default option.
Some Questions and Answers …
Question: Why is there a Trial Period for
Some, But Not All, Options?
Answer: Gale et al (2008) discuss rationale for
trial period. This is desirable when a
significant portion of the account is
annuitized at once. With “laddered”
annuitization, no more than 1/8 of the total
account balance will be “irreversibly”
annuitized.
Some Questions and Answers …
Question: What about Counter-Party Risk?
Answer: Others have suggested PBGC-like
backstop. I would prefer to limit risk through
effective risk management, reinsurance, risk
securitization, and possibly multi-provider
solutions.
Summary
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Annuitization is a key component of
retirement income security
Policy intervention is needed to encourage
plan sponsors to provide it as an option
Defaults and “auto” options have proven
effective in other aspects of retirement
planning process, and they are likely to work
here as well