With Social Security Depleting, Can Annuities Assist Retirees Who Have Less Savings?

Social Security funds are being depleted faster than previously thought, pressuring future low-income workers hoping for retirement.

A vital source of retirement income for most Americans, Social Security is an inflation-adjusted annuity that would pay a 65-year-old employee who made $80,000 in their final year of working about $1,880 per month if they retired this year, according to an estimate using the Social Security Administration’s benefits calculator.

By 2034, without further modification, Social Security would have enough revenue from current workers’ payments to pay out only 81% of payable benefits, affecting most workers, but especially those with less retirement income.

Baby Boomers, currently aged about 51 to 79, have an average of $250,000 saved in their 401(k) accounts, according to Fidelity Investments. Fidelity suggests retirees should save about 10 to 12 times their annual income by the time they wish to retire.

Savings of $250,000 by age 65, the current age at which many workers wish to retire, would represent 10 times an annual salary of $25,000, below minimum wage in several states. In other words: A majority of retirees have not saved enough for retirement.

Can Annuities Help?

Experts believe a relatively new product, annuities, can work as a sort of insurance for retirees, to make sure they do not run out of money.

In 403(b) plans, annuities have worked for years, but they have not realized the same level of adoption in 401(k) plans. Some experts say that 403(b) plan participants—who generally include employees of public education institutions, nonprofit organizations (including hospitals) and certain religious organizations—tend to have more familiarity with defined benefit plans, making them more supportive of annuities.

“If you think about the narrative with which you, as an employee, were raised, if you worked in the public sector, they usually had generous pension plans,” says Gopi Shah Goda, director of the Retirement Security Project at the Brookings Institution. “Annuities, in some ways, are that transition selling point to help you understand: You’re not getting a traditional pension anymore, but you’re getting something that simulates the pension.”

For 401(k) plan participants, annuity take-up is lower, with many retirees left without a comprehensive decumulation strategy for effectively utilizing their savings.

In considering whether annuities could assist retirees from lower income brackets, it is critical to note that they are usually irreversible. The retirement solution often requires individuals to commit their retirement funds to a series of planned payments, which can be burdensome unless the participant has access to other sources of flexible liquidity.

“Annuities are much more common among affluent retirement savers who have substantially grown other tax-advantaged vehicles like 401(k)s and IRAs, and who can afford to lock up substantial sums while maintaining liquidity elsewhere,” says Romi Savova, founder and CEO of PensionBee. “Lower-income individuals are more likely to need access to their limited savings for emergencies.”

Does the Math Work?

For example, a fixed annuity purchased for $100,000 at a 6% interest rate over a 20-year timeline would pay out about $700 per month.

In this scenario, a retiree who could afford the annuity would receive $700 a month for the bulk of their retirement, which could be used to pay monthly expenses—since, after all, consumers shop on a monthly basis, according to experts. The money could also be used to pay for unexpected medical expenses more likely to occur in retirement. However, the $100,000 price tag—which does not need to be paid in a lump sum—could be too pricey for a retiree who is behind in their retirement savings.

“Many individuals can also be put off by making life-changing financial decisions without the help of a human financial adviser; however, financial advisers are only typically available to individuals with over $200,000 to $250,000 in assets,” Savova says. “Ironically, it is actually individuals on lower incomes who may benefit most from guaranteed income.”

By design, guaranteed income products target retirees who already have substantial savings that enable them to convert a portion into guaranteed income while maintaining liquidity elsewhere. Such a strategy can supplement Social Security benefits for those who can afford to do so.

But according to Jason Fichtner, a senior fellow at the Bipartisan Policy Center, annuities have a place for retirees even within lower income levels. In fact, he argues it might behoove plan sponsors to offer annuities that work like Social Security in some ways, to result in broader adoption.

“Social Security is the largest annuity in the United States, and it’s an inflation-protected annuity,” he says. “What if we offered a product in your 401(k) plan that’s a bridge annuity that simulates your age-62 benefit until you turn 70, and then Social Security kicks in?”

Increased Interest

For now, many plan sponsors are hesitant to offer annuities, although recent industry surveys have indicated an increased willingness to offer the insurance products and an increased interest from plan participants for guaranteed income solutions.

While they are still tilted toward higher-income earners for now, annuities could eventually supplement Social Security benefits for lower-income workers.

“There’s still a lot of value in potentially having some assets annuitized for lower-income households,” Shah Goda says. “But they’re at a different starting point because of Social Security.”

According to Shah Goda, many consumers think of expenses on a monthly basis, such as large bills like a mortgage or car payments. Having an extra fixed amount paid per month gives retirees a familiar feeling: receiving a paycheck that is guaranteed. It also removes a fraction from the most challenging equation of retirement: how to make sure the money lasts, Shah Goda says.

“You’re more protected with an annuity then a [do-it-yourself] decumulation strategy,” she says.