'Puzzle' Pieces

Academics have long agonized over something they call the annuitization puzzle.

Simply stated, the thing academics can’t quite understand is the reluctance of American workers to embrace annuities as a distribution option for their retirement savings. Some of that is because they assume workers are “rational” when it comes to complex financial decisions, specifically because “rational choice theory” suggests that at the onset of retirement, individuals will be drawn to annuities because they provide a steady stream of income and address the risk of outliving their income.

Compounding, if not contributing to that belief, are surveys – albeit surveys generally published, if not conducted by, annuity providers (or supporters) that consistently find support from participants for the notion of reporting benefits as a monthly payout sum, if not the notion of providing a retirement income option. And yet, despite those assertions, in the “real” world where participants actually have the option to choose between lump sums and annuity payments, they pretty consistently choose the former.

That said, a study by the non-partisan Employee Benefit Research Institute (EBRI) also supports the notion that plan design matters, and matters to a large extent, in those annuitization decisions.

Over the years, a number of explanations have been put forth to explain this reluctance: the fear of losing control of finances; a desire to leave something to heirs; discomfort with entrusting so much to a single insurer; concern about fees; the difficulty of understanding a complex financial product; or simple risk aversion. All have been studied, acknowledged and, in many cases, addressed, both in education and in product design, with little impact on take-up rates.

Yet today the annuity “puzzle” remains largely unsolved. And, amid growing concerns  about workers outliving their retirement savings, a key question – both as a matter of national retirement policy and understanding the potential role of plan design and education in influencing individual decision-making – is how many retiring workers actually choose to take a stream of lifetime income, versus opting for a lump sum.

‘Avail’ Ability

Some of that surely can be attributed to the lack of availability. Even today, industry surveys indicate that only about half of defined contribution plans provide an option for participants to establish a systematic series of periodic payments, much less an annuity or other in-plan retirement income option. Indeed, I’ve never met a plan sponsor who felt that the official guidance on offering in-plan retirement income options was “enough.”

Enter the bipartisan Retirement Enhancement and Security Act (RESA), which includes a provision to require lifetime disclosures – and while its prospects seem bright, it remains only a prospect. Closer to a current reality is Tax Reform 2.0, but the retirement component of the legislation approved by the House Ways and Means Committee on Sept. 13 did not address the subject – or at least didn’t until the Chairman Kevin Brady introduced a Managers’ Amendment that largely, if not completely, mirrors RESA’s.

That 8-page addition outlines a “fiduciary safe harbor” for the selection of a lifetime income provider, which, as its name suggests, binds the liability to a consideration “at the time of the selection” that the insurer is financially capable of satisfying its obligations under the guaranteed retirement income contract. It also clarifies that there is no requirement to select the lowest cost contract, and that a fiduciary “may consider the value of a contract, including features and benefits of the contract and attributes of the insurer” in making its determination. Moreover, there is language that notes that “nothing in the preceding sentence shall be construed to require the fiduciary to review the appropriateness of a selection after the purchase of a contract for a participant or beneficiary.”

At this point, it’s impossible to say whether this legislation will be signed into law, much less whether it will prove sufficient to assuage the concerns that have continued to give most plan sponsors pause in adopting this feature.

A couple of things seem clear, however. First, as long as plan fiduciaries continue to feel vulnerable to a generation of potential liability for provider selection beyond the initial selection, they aren’t likely to provide the option.

And participants who are not given a lifetime income choice as a distribution option will surely not (be able to) take it.

- Nevin E. Adams, JD 

See 5 Reasons Why More Plans Don’t Offer Retirement Income Options