A New Option for the Retirement Crowd

As a growing number of Americans worry about outliving their retirement savings, the government is encouraging employers to offer an old-school, pension-style option for 401(k)holders.

elderly woman with financial advisor
Rolf Sjogren | The Image Bank | Getty Images
elderly woman with financial advisor

The proposed revamp of retirement fund rules would make it easier for workers to convert part of their 401(k) savings into an annuitythat would pay guaranteed income checks for life — no matter the ups and downs in the markets.

And in keeping with the new assumptions about retirement, there is an unconventional component; a “longevity option” would let 401(k) savers take a lump sum portion at retirement age and defer it for 20 years, so retirees would start getting steady checks in the mail at age 85 and beyond.

Investment advisers say that’s a big improvement on the “all-or-nothing” choice of many current plans, which allow retirees to take their entire 401(k) as a lump sum in cash or convert the whole thing into an annuity, instead of a combination of options.

“The new regulations give people more flexibility,” says Warren Ward, a financial planner in Columbus, Ind. “You could put a third into an annuity and invest the remaining lump sum or keep some cash handy for medical needs and emergencies. It can give people piece of mind, which is important. After you work for your whole life, you don’t want to worry about money when you get to retirement.”

The U.S. Treasury proposal to encourage partial annuity options for 401(k) investors comes as Americans contemplate longer life spans while being spooked by the drop in value of retirement portfolios in the wake of the 2008 financial market meltdown.

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A recent survey from global financial services association Limrafound that 40 percent of Americans don’t feel well informed about generating retirement income, investing their nest eggs, or managing their risks and expenses.

The survey, cited in a recent edition of Financial Advisor Magazine, also found that less than 50 percent of Americans plan for more than 20 years of retirement.

Only a handful have factored in how they might cover the cost of health care, long-term care, rising taxes and inflation ,and what they might do in the event they outlive their savings.

Less than 35 percent believe they’re stashing away enough to last for their retirement.

Peter Velardi, president and chief operating officer of FiPath, an independent financial planning site, says the proposed 401(k) annuity option addresses two concerns: people living longer and the vast retirement savings lost since 2008.

Guarantee vs. Control

But consumers must be sure they understand the trade-offs and risks, says Velardi.

“It feels like a pension, but the big difference now is consumers are taking responsibility for it,” he says. “I wouldn’t say everybody should do it, but it could be a very good idea for some."

While the annuity is an opportunity for guaranteed lifetime income, the trade-off is a loss of control and liquidity as well as the loss of potential upside from keeping the money invested in the markets, he says.

For instance, the funds signed over to an annuity couldn’t be tapped to cover unexpected health care needs.

“You need to be self aware about what your spending habits are and your health and filter that in,” says Velardi. “It isn’t always the best idea if you don’t have enough cash reserves.”

For those choosing the annuity option, financial advisers recommend a tiered approach, with a portion in an annuity — the most conservative investment option — another bucket that is safe, but more liquid with an opportunity to get a higher-than-fixed return and a separate rainy-day fund.

While pension-style, lifetime payouts were once the norm in the United States, the private pension system has steadily shifted toward single-sum cash payments.

According to the Treasury, of the $11.2 trillion in private- pension assets tallied last year, only 21 percent was held in defined benefit plans. Employee contribution plans like 401(k)s accounted for 36 percent and individual retirement accounts (IRAs) were 43 percent.

The government notes that a 65-year-old woman now has a 50 percent chance of living past age 86, and a 65-year-old man has the same odds to live past age 84, increasing the possibility that Americans might burn through their savings.

With the “longevity annuity” option, a 65-year-old retiree would only pay around $35,000 for a $20,000-a-year annuity that would kick in at age 85, compared with more than $277,000 for an annuity that would start paying out immediately, the White House Council for Economic Advisers estimates.

“The truth is, anything we can all do to make it easier to survive retirement is going to make it better for all of us,” says Ward. “It means, there’s not going to have to be another social program to help all these people out.”