Money Talk

Little help? An annuity isn't the answer to the nation's 401(k) retirement woes

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A new bill that aims to help workers create a more secure retirement recently passed the Congress overwhelmingly by a 417-3 vote. 

Too bad it misses the mark.

Among other things, the bill will allow 401(k) plans to include annuity products — meaning, participants would receive a fixed amount per month. In a nutshell, an annuity (specifically, a fixed annuity) provides a guaranteed amount of income, based on how much you put in the annuity. The guarantee comes from the insurance company selling the annuity.

The problem people have with saving for retirement isn't a lack of available annuities. The biggest problem most 401(k) participants face is that they simply don't save enough to grow a robust nest egg, and annuities aren't going to fix that. Savers encounter a range of potential pitfalls when investing in a 401(k). Fees can be high. Investors are often undereducated about how to structure their investments. And too many 401(k) participants make poor decisions, such as buying or selling frequently.

As a matter of fact, annuities may end up harming savers to the extent that they come laden with fees, as is all too common.

How was this supposed to help?

If you have savings in an array of mutual funds, as 401(k) plans are currently structured, it is unclear how much income you might be able to expect from that nest egg. The theory is that an annuity will allow you to see exactly how much income you can get in retirement. While there is nothing magic about annuities, economists tend to agree that annuities are a great way to finance retirement spending, mostly because they remove uncertainty about how much you can safely spend.

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However, I argue that The Center for Retirement Research at Boston College reports that the typical household approaching retirement had $135,000 in combined 401(k)/IRA assets at the end of 2016. If that typical married household were to buy an annuity at age 65 that provided income for either spouse while they were alive, it would amount to about $600 per month.

Aside from home equity, 401(k) plans and IRAs are the most significant financial asset for most people. While converting that retirement asset to a stream of income may be a smart way to help cover everyday expenses, the strategy would leave little in liquid assets to cover an emergency, such as a long-term health care need. About $600 per month, with no cost-of-living increase and leaving nothing for emergencies, is not what I would consider a secure financial situation.

Wait to retire

Annuities in a 401(k) plan are not going to change the quality of life for most people in retirement. There are far more impactful decisions that workers can make to ensure a more secure future. For example, many workers claim Social Security at 62 years old. At that age, a worker is entitled to 75 percent of his or her "full" benefit. Simply waiting until the full retirement age to claim benefits may be just as beneficial as that $600-per-month annuity.

Moreover, a worker who can delay claiming until age 70 will see their benefit increase further, an additional 32 percent for workers born between 1943 and 1954.

Social Security benefits have the added benefit of increasing with the cost of living, unlike most annuities. Workers can create a more secure retirement by working a few years longer, saving more, spending less, and delaying Social Security. These simple solutions are far more impactful than opting into an annuity.

While the congressional motivation to make retirement more secure for Americans is noble, annuities will do little to improve the lives of retirees.


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