In the wake of the worst stock market performance in decades, there's a drive under way to include a new type of product in 401k plans: an annuity-style investment that gives retirees guaranteed income for life.
A number of insurers, eager to grab a share of the baby-boomer retirement market, are introducing these products for retirement plans. Besides the guaranteed income, proponents say these investments offer greater fee transparency and withdrawal options than traditional annuities and can even be folded into target-date mutual funds.Vanguard Group's Center for Retirement Research. "How are they going to take lump sums (at retirement) and make something of them to last the rest of their lives?"
There's one big problem, though: Many investors just don't seem to want these annuities, even if a bevy of financial experts say the products are in their best interest. Meanwhile, many employers don't want the burden of choosing -- or taking responsibility for -- investments that promise to protect their employees for the rest of their lives.
Why are investors reluctant to opt for these annuity-type investments? A big part of it is people's long-standing perceptions. Annuities, offering fat commissions to those who sold them, have developed a reputation for sales abuses. They require you to cede control of the money to an insurance company. And some people fear they'll die before receiving the financial benefits.
For an idea of how reluctant people are to take the annuity plunge, consider this: Money-purchase plans -- similar to 401k's -- are required to offer annuities as a way to take distributions come retirement. But Vanguard's Utkus says that among such programs overseen by his company, "the rate at which people exercise that option is negligible, like 5%."
Several years ago, Vanguard did a study of a Fortune 500 company's pension plan and found that about three-quarters of people reaching retirement age opted out of the annuity, a step that required having a spouse sign a release form in front of a notary.
Not an easy fitUntil recently, investors rarely faced the choice of annuity options in their 401k's, because combining annuities with 401k plans was like trying to jam a round peg in a square hole.
With a classic "immediate" annuity, an investor hands over a lump sum to an insurance company that promises in exchange to pay a set amount -- say, every month -- for the rest of the buyer's life. But in their early days, 401k plans were meant to be supplemental savings plans for workers who already had pension plans providing steady lifetime income. And that was on top of Social Security payments. So 401k plans provided lump-sum payouts at retirement.
Along the way, the selling points of 401k plans became transparency and individual control. As the plans became widespread, mutual fund companies became the dominant managers of 401k's, rather than the insurance companies that provide annuities.
Of course, investors could always convert a portion of their retirement payouts on their own to immediate or deferred annuities that would guarantee income streams sufficient to cover day-to-day expenses. But here the reputation problems of annuities came into play.
At the same time, the plumbing of 401k plans made getting annuity products to investors a challenge. When an investor buys or sells a mutual fund in a 401k, the record keeper aggregates the information and simply sends an order to buy or sell on behalf of the plan rather than the individual. With an annuity contract, the insurer needs to keep track of each individual's holdings; that is requiring record keepers to reconfigure their systems, a slow process.