Cover | Published in July 2009

Leading the Horse to Water

Legislation may nudge plan sponsors to reconsider annuities—but what about participants?

By Judy Ward | July 2009
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Illustration By Marco Wagner

The market's recent plunge likely frightened more Americans into a willingness to consider putting at least some of their 401(k) assets in a retirement-income product at retirement. Now, Congress may give them a nudge to go ahead with it.

Support for tax advantages for annuities, previously proposed in 2005 by Rep. Earl Pomeroy (D-North Dakota), seems low this year, given the government's other current financial demands. However, several other ideas appear to have potential traction, and they speak to the logistical and psychological reasons that many see at the heart of 401(k) participants' continued aversion to retirement-income products—the overall inertia, concerns about the complexity and cost of choosing an annuity on the open market, the fear of losing money to unstable financial institutions, and the impression that a series of small payments made over time has less value than one big lump-sum payment.

"As we bring more people into the system, we will need to address the longevity risk," says David Certner, AARP's Director of Legislative Policy in Washington, pointing to the Obama Administration's auto-IRA push. "Having a better-functioning annuities market would be very helpful."

Three Possible Solutions

These three possibilities seem the most discussed currently:

Auto-enrollment in annuities: Nonprofit public-policy researcher The Brookings Institution has proposed a "test drive" that would automatically enroll defined contribution participants in an annuity for two years after they retire. Congress would establish an acceptable range of default balance put into the annuity—say, 50% to 80%—and each employer could choose the best percentage for its workforce, says William Gale, a Brookings Vice President and Director of the Retirement Security Project. Employees could opt out or change their percentage, he suggests.

A government mandate to purchase annuities "would be a step in the wrong direction," Gale stresses. An annuity does not work best for everyone, he says, and, even when it does work well, a bunch of variables mean no one annuity setup is right for everyone. "It is very important that these things remain voluntary," he says. If people get the wrong annuity, he says, they "have made a big, permanent mistake."

Gale also favors the government coming out with QDIA-like guidelines for annuities, to ease employers' worries about fiduciary issues. "I would like to see that: 'You tell me what the acceptable situations are, and I will pick one,'" he says. "We need a safe harbor for payout options, like we have for investment options."

From an employer perspective, sources agree, auto-enrollment succeeds in giving many more participants access to a retirement-income vehicle. With opt-out rates low for automatic enrollment in 401(k) plans, "it is not likely that they will opt out" of auto-enrollment in an annuity, says Robyn Credico, Arlington, Virginia-based National Director, Defined Contribution Consulting, at Watson Wyatt Worldwide.

"Automatic enrollment seems to work, period," Certner says, "so it would probably work for anything." In this case, too, it likely would "harness the power of inertia," he says. AARP previously backed legislation from former Illinois Sen. Carol Moseley Braun to require joint-survivor annuities as an option in defined contribution plans, he adds.