SURVEY SAYS: Should There be a DC Distribution Default?

May 27, 2010 ( - While there is a growing interest in crafting/implementing/deploying a workable lifetime income solution, most of the historical evidence to date would suggest that participants remain hesitant. 

This week, I asked readers if they thought that defined contribution plans should have an annuity default distribution option.  The results were, as you might expect, intriguing.

A clear plurality – 38.4% – said “no”, while fewer than half that number (15.2%) said “yes.” 

Now, one-in-five (20.2%) said “not until the products are ‘better’”, one-in-ten (10.1%) said “not until there is a regulatory safe harbor”, and 6.1% said simply “not yet.”  The remaining 10% were “not sure.”

But, as I said, the verbatim were interesting and insightful – as you’ll read for yourself on the following pages:

In spite of being against government overregulation and overpayments for many insurance annuity contracts, I think that annuity options should be made available in DC plans.  While participants can go outside to purchase an annuity option, I don't believe most participants have the ability to properly research the options out there and the related costs.

There needs to be a more defined set of rules regarding the standards for the product, and education. (minimum standards)   The participant would be guided into a product.  We need to ensure that it is a product that will meet the needs of the average participant.

Too many questions to ask...what is the security for the retiree with respect to default of the carrier?  What liability for the employer?  If the retiree does not understand the trade-offs, what is the recourse?   

It's too complicated an issue for a simple "yes" or "no" answer.

Our Plan has an annuity feature.  For the 11 years that I've been its administrator, not one person has elected the annuity.  Generally, large balances get transferred to other investment vehicles and small balances are taken as cash distributions.

As a provider, my company offers an annuity option to our clients that I fully support.  That said,  I personally don't like offering any default option that includes an extra cost to the participant.  If there is a cost, I prefer that the participant make an active choice to incur that fee for the product or service.

An annuity option should be offered, but not as a default.  Another solution would be an option that would recalculate monthly payments annually based on the remaining account balance and remaining life expectancy.

Does Social Security offer a lump sum?  😛

I guess I'd have to know what that is, if I were to offer a true answer.

Our DC plan has had an annuity option for many years.  Employees may not opt for an annuity, but it is available as a choice.

I would like to see providers offer this option and plan sponsors should include it in their plans.  I am more hesitant about a mandate that would drive up the costs of plan compliance and potentially encourage the use of uncompetitive annuity products.  I also feel that there is room for improvement in annuity products and the marketing of these products.

No, No, No. Annuities should never be a default option - they're way too complicated.

Auto-enroll was implemented because employees, when left to their own devices, would not enroll in any 401(k) plan because it takes effort and they think they need every cent in their take home pays.  They are better off for it because when most people are enrolled automatically, they don't opt out.  Same goes for an annuity option--unless the participant opts out, it should be automatic to provide a stream of income at retirement so that participants have some monthly income after retirement age. Participants don't know what to do with their 401(k) balances and will take it out in a lump sum and drop it in their bank savings account, pay taxes on the interest, and withdraw it and spend it if we don't encourage them to provide a steady stream of income for themselves.

If there is any default option, it should be a certain percentage of the account balance, varying by age at retirement, paid out each year and adjusted for inflation. The percentage should be in the area of 4% or so at age 65, which will last for most people's lifetime (and often with a substantial balance outstanding at death), although there would be no guarantee of the result. An individual could "opt out" of this arrangement at any time. Requiring a default to annuity (or any guaranteed option) benefits the annuity providers' pocketbooks more than anything else at the expense of individual retirees. No one should be placed in a guaranteed product without explicit decision to do so and only after full disclosure of all cost, benefits, and risk.

"If a participant wishes to annuitize, they should do so at Retirement.  The choice a Plan Sponsor makes for all of its employees will rarely be the best choice in terms of an individual annuity.  At Retirement, the participant, along with their Advisor, can review the market place for the right annuity for the individual.  The Annuity options on the Plan level are typically not portable if the Plan changes providers may restrict the Plan from making changes it might ordinarily make in order to retain the Annuity by sticking with the provider. 

In short, this decision is better served to the individual at Retirement."

The annuity distribution option should be available on a voluntary basis but it should not be the default. I also think the annuity option should be outside the plan because current DC plans are not structured to pay lifetime annuities.

"No, in my opinion it's a safety net against the late baby-boomer generation mantra. ""Don't tell me what to do but I'll sue if, heaven forbid, you don't protect me against myself"". In tune with a Wizard of Oz song;

Ding-dong the DB's dead, y'er on your own, get it in y'er head

Ding dong the DB plan is dead. Hi ho it's all your dough,

spend if fast, spend it slowHi ho you choose the way to go."


Absolutely yes!!  As we've seen, so many Americans have a difficult time with budgets or staying within them.  This is one way to help assure an income stream for life rather than having participants get a lump sum and blow it in the first five years.

"The problem is that every person reaches retirement in their own personal financial situation. An annuity option is not right for everyone but being able to opt out of the annuity does allow those who are on top of their finances to choose what is right for them and forces those who should have an annuity to consciously make a choice to something different (albeit making that choice may not require thought if all one has to do is check a box next to the lump sum amount).

It is understandable that participants remain hesitant. Trading in a big chunk of money for a monthly amount that doesn't really seem that big is not appetizing. Fearing that one will die before ""getting their money back"" also keeps people from annuitizing despite the evidence that suggests people are living a lot longer. Individuals tend to have a pessimistic view of their own chances of living longer and of enjoying that ""small"" monthly payment if they do happen to live longer.

As a plan sponsor, it is hard to trust annuity providers because they're a lot like car salesman. There's not a lot of disclosure of a real price for products. Plan sponsors need products with an extreme amount of disclosure. We must be able to compare apples to apples in terms of features and costs of annuity type products. As plan sponsors, we must demand that from providers."

Sometimes I wonder how far is too far with the default decisions - but faced with the fact that many participants do not pay any attention to this, it's a big brother approach.  Isn't that what the government gets criticized for?  I am just glad that my father drilled into me and my siblings to save early for retirement.

Employers are reluctance to consider any provison that may increase their potential fiduciary liability.  Only realistic way to foster use of retirement income annuities is simply to have a modest tax offset, such as excluding from income up to $10,000 a year (single/ $15,000 for MFJ) - then each indiviudal's enlightened self interest will take over - cost to federal treasury would seem to be worth.

Maybe lump sum distributions should be eliminated in favor of some type of installment payment arrangement.

"I've heard from several insurance reps I know that the majority of clients that buy an annuity before retirement do not actually take the annuity at retirement, but chicken out and take a lump sum. I don't know if there are real statistics that support that. But insurance companies make out on that scenario.

I would like to be able to offer an annuity product and do some realy education around it, but the ""product"" for a 401(k) plan is not out there yet.  I think they have improved but need more work on fee disclosure and transparency, as well as cost and flexibility."

In all my years of administering these plans, I have seen my share of participant lawsuits, but never one in which the retiree sued the plan on the basis that he did not have enough income after misusing the assets he withdrew from the plan.  Not sure what will happen if the default is an annuity, the retiree accepts it, runs short of money and sues because either 1) he didn't understand what he was doing, 2) the returns or expenses are unfavorable, 3) the annuity provider defaults, or any other issues you can think of...

Companies with DC plans should be permitted to also have DB "tail" plans, a separate plan that pays life annuities starting at age 85.  The plan would be relatively cheap, since most participants won't live to collect more than 5 to 10 years of benefits, but would protect a retiree against outliving their money.  This way, the DC account balance could be managed against a defined ending date (age 85) and the longevity risk is pooled in the DB tail plan.

"This decision should be made at the plan sponsor level, so it can be calibrated relative to their workforce and other employee benefit programs, as well as their corporate culture.

Remember, we had annuity options in many plans before, and have amended them out over the years because of the compliance hassles they created. If such an option creates even more work for the PS, it will not be embraced."

Individual circumstances in the distribution of assets are even more different than they are when accumulating assets. One size fits all works even less well in distribution than accumulation.

One more step in big brother protecting the masses from themselves, but I do think that if the products weren't too expensive, an annuity could be a good choice for someone who would otherwise plow through their balance within the first five years.

Several church plans currently have had to reduce current payments and future guarantees for annuitized DC's a slippery slope we climb when trying to make life risk-free!

"My answer is an emphatic NO.

Let's begin with background.  In the mid-80's I was manually calculating SPIA's (single premium immediate annuities) from an actuarial table.  I understand very clearly the impact of factors such as INTEREST RATES and LIFE EXPECTANCY as well as whether a 10 year certain and life, life only, joint and survivor, joint and 2/3 survivor, etc. are chosen.  (Remember Jimmy Carter and prime rates at 18.5%?  We were basing SPIAs on 13% interest assumptions.)

Personally, it is my opinion that anyone who locks themselves into an immediate annuity at this time is being foolish if they believe they will live very long.  (Quite noticeable that no regulator is mandating explanations of this to customers although I am sure this will come when interest rates rise and those who bought now and did not realize the impact the low interest rate has on their payout begin their complaints.)

This does not consider individual variances and I believe it is a slippery slope toward mandated annuities.  Am I the only one that realizes that many in government want us to be dependent upon them?  We do so much better when we take responsibility for ourselves.

Consider one person I know well.  He retired from XYZ Company after 37 years and took the lump sum (it was actually a lay-off and he was only in his early 50's having begun there at 18).  He rolled the funds into a solo (k) and was able to borrow 50k to purchase a small moving business.  Within 3 years he had grown that business to where the advertising budget was as much as he had paid for it.  He could not have done that with an annuity.  Then, this same person, had an ""Oops"" a few years later and ended up having a new baby.  While most would think someone with 37 years with one employer would be able to make a decision regarding future income and inheritance needs this is clearly not the case for this person.  There are more and more folks who make major life changes later and later in life.  Voluntary or not, the decision to annuitize assets can impact the ability to follow your dreams later.

Another example is a man who has a nice retirement income close to six figures.  He is not insurable for life insurance but he is comfortably retired driving around in a Cadillac Roadster convertible on sunny days and his Jeep Renegade when it rains or staying home watching the golfers on the course behind his home.  Nice life, right?  But then he fell madly, deeplly in love.  He wanted so much for the object of his attention to retire so they could just play and enjoy life but he had not chosen spousal options for his retirement and had not been saving because ""the pension God just brought him a new pile of money every month"".  She could not feel safe retiring.  She made more than his pension and was not willing to face being poor, or at a much lower income level, when he passed but there was no guarantee that he would live long enough to save enough to provide for her.

These are two stories I have been very close to.  I am sure everyone has seen other reasons not to go down this path."

Starvation is such a cruel way to go.

While there does not at present seem to be interest in this product, I believe that a default annuity option, combined with an insurance product to prevent participants from 'outliving' their money would  very popular, if the annuity product does not have outrageous fees associated with the set up or operation of it.

There's so much attention being granted to health care, I can only wonder what the powers that be will do when retirement reform becomes the hot topic.  Provide adequate health care and people will live longer... but they won't be able to afford it!

DC plans are supposed to give employees control over their retirement savings.  They also, at least initially, removed some administrative barriers that made DB plans dificult and expensive for many sponsors.   The more administratively burdensome we make them the more they look like DB plans, and the less appealing to many sponsors.  If participants want an annuity, there are plenty of annuity providers in the open market fighting for their business.

Many plans continue to have annuity options because of merged money purchase pension plans.  From my experience (MANY years ---), no one opts for an annuity payout.  The preferred choice is a rollover to an IRA which allows the individual to schedule payments that fit their needs.  It seems to me the insurance industry is lobbying for this - more revenue (especially if a straight life annuity is chosen and the participant passes).  It would, however, insure job security for those of us in this field who don't work for an insurance company -----

The choice of annuitizing a defined contribution account may be too much for a retiree.  There are so many different options that it would likely paralyze the decision maker.  This is a difficult decision and should only be made after speaking face-to-face with a financial plannner and tax advisor.  The decision is too permanent to be made with the help of a customer service rep who may not fully know what's best for the client no matter what type of fact finder they are trained to assit them in this  process.

"When I worked on DB and other pension plans, I never had a single participant choose the J&S distribution option. Once we had a distribution that had to be made that way because the participant's spouse would not sign the waiver.

Adding that requirement to non-pension plans would only increase the amount of paperwork required to process distributions."

More education is required.  A lot of people don't understand annuities.

"Incredible increase to cost of plan mgmt.  Who prepares/pays for the annuity calculations?  Who carries the risk of excess longevity? How small a dollar are you willing to go for a lifetime of check processing and postage costs?

Employees must take responsibility for their own lives and retirement savings.  We should offer an opportunity to save during their employment.  Default contributions are very successful (mostly due to the incredible inertia of the participant) but I would argue they are set too low to be anywhere near enough."

I believe participants will go with the default and wind up paying fees inherent in annuties that they did not need to do.

People tend to get angry when you do things with their money that they feel they did not authorize . . . . roll their money to default IRAs, impose a vesting schedule on employer money, transfer their money due to a fund change in the plan, follow rules regarding "distributable events", withhold taxes from cash distributions  . . . . It does not matter how many times you notify them of what can and cannot be done within the plan.  Imagine what they will do if you "decide" to annuitize their money.

"This area is ripe with opportunities for product development.  Although it is still early, I fear that we will see a large number of retirees who outlive their accumulated savings and live much of their retirement on little more than Social Security.  This poverty-level existence will be the source of the next great ""benefit crisis"" for Congress to try to fix.

A reasonably priced vehicle for providing lifetime income to retirees would be a huge improvement over spending down a lump sum, and is desperately needed."

Not sure it should be the default, but it would be nice to see it as an option.  Too many people don't know what to do with a big chunk all at once, and might not make the best guess each time they need to withdraw---too much, too little?

I can't wait to see the regs on this one.  Welcome back DB plans!!!  And on behalf of all other Enrolled Actuaries THANK YOU!!!

But this week’s Editor’s Choice goes to the reader who noted, “A better solution already exists: a defined benefit plan.”