Automatic Lifetime Income as a Path to Retirement Income Security - PowerPoint PPT Presentation

1 / 26
About This Presentation

Automatic Lifetime Income as a Path to Retirement Income Security


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 ... – PowerPoint PPT presentation

Number of Views:174
Avg rating:3.0/5.0
Slides: 27
Provided by: JR170


Transcript and Presenter's Notes

Title: Automatic Lifetime Income as a Path to Retirement Income Security

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
  • University of Illinois at Urbana-Champaign
  • Associate Director, Retirement Research Center
  • and Research Associate
  • National Bureau of Economic Research

Retirement Income Security as a Goal
  • 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
  • Large economics literature on the benefits of
  • 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
  • Congress should encourage plan sponsors to use
    life annuities as the default distribution option
  • Issues that I will address today
  • What are the objectives of an auto-annuitization
  • 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
  1. Make annuities available to DC plan participants
  2. Change the conversation
  3. Preserve individual choice
  4. Keep it simple, while encouraging innovation
  5. Avoid irreversible participant mistakes
  6. Minimize the burden for plan sponsors

Suggested Policymaker Actions
  • Provide default annuity fiduciary relief
  • 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
  • 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
  • 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?
  • Triggered upon request by employee for
    non-hardship withdrawal
  • At time of request, the account is divided 50/50
  • Cash Account and
  • Annuity Account
  • Annuity account (if not already in annuitized
    form) would be converted to an annuity,
  • 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?
  • 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.
  • 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
  • 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?
  • 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
    2-5 annually, OR indexed for inflation
  • Plan sponsors would be permitted to impose a
    minimum annuity account size of no greater than

How Design the Auto Annuity Plan?
  • Credit for in-plan annuities
  • 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
  • Lifecycle funds that gradually convert into
  • Plans that place employer match into annuity
  • Deferred life annuity contracts as an alternative
    to fixed income investment options

Example 1
  • Gale, Iwry, John and Walker (2008)
  • Individuals defaulted into 2-year trial income
  • 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
  • Laddered annuitization
  • 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
  • Individual can opt out at any time.

Example 3
  • In-plan annuity examples
  • Using deferred life annuities as an alternative
    to fixed income vehicles
  • Directing employer match into deferred payout
  • 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 wont 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 dont 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 Isnt 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
    pre-retirement 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
  • 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
  • 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

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
  • 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 in-plan 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 participants 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

  • 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
Write a Comment
User Comments (0)