In a recent article in Forbes, Dr. Jeffrey Brown addresses an important point about the focus of 401(k) plans being ultimately on spending capacity throughout retirement. I have written before about the DC industry being extremely efficient in the asset accumulation phase. When it comes to the decumulation phase, however, it does not get the same high grades.
The title of Brown’s article, “Income is the Outcome,” is spot-on. True, participant statements often include an estimate of how much total retirement spending capacity their current DC balance will support. But the focus needs to be on creating products that facilitate prudent decumulation in a way that participants’ greatest fear of outliving their assets is never realized.
Brown points out that, “Annuities and other guaranteed lifetime income products can solve this problem.” I happen to agree with him. So why is it that so few plan sponsors offer in-plan retirement income products? “Part of the answer is that regulators scared 401(k) plan sponsors away from offering annuities,” he writes. For the first three decades of the 401(k) plan’s existence, plan sponsors were lead to believe they were subject to an impossibly high fiduciary standard: that if they were to provide an annuity, it had to be the “safest annuity available.” This created a perverse situation in which plan sponsors who provided employees with an annuity lived in fear of being sued.
Meanwhile, plan sponsors who left employees to fend for themselves were given a free pass. By the time the Department of Labor clarified in 2008 that the “safest available” provision applied only to DB plans, the damage was done. Most 401(k) plans were built without any options for guaranteeing income for life. Brown’s recommendation is that, “The Department of Labor needs to establish a clear safe harbor so that employers who want to ‘do the right thing’ can offer in-plan annuity options without fear of tripping over fiduciary rules.”
But as the Forbes article points out, that is only half the problem. Participant and consumers in general have a conditioned neutral or negative response to annuities. Interestingly, Brown attributes this in part to the way annuity providers have “framed” their product within the DC space. “The (other) problem is that we have conditioned 401(k) participants to shun annuities. Nearly every aspect of our 401(k) system — from rules governing minimum distributions to how we design account statements — has taught participants to measure their success in retirement planning by looking at their account balance. We should have been teaching them to think about how much income their 401(k) would provide them each month after they retire.”
Brown continues, “This framing effect is powerful: when an annuity is compared to a savings account using investment-oriented language, only about 20 percent of respondents report that the life annuity is preferred to the savings account. When the same information is presented in a consumption frame, the fraction preferring the annuity jumps to approximately 70 percent. Thus, nearly half the population changes their views about the relative desirability of a life annuity and a savings account based upon simple changes in how the products are described, even though the information content is unchanged.” (A summary of this research can be found here.)
As Brown suggests, policy changes are in order. Obviously this will help, but that will help only if the focus of the DC plan between accumulation and efficient and effective decumulation is balanced. As the title of the article says, “Income is the Outcome.”
