(Bloomberg) – Millions of retirees still live off traditional pensions. Checks from a former employer arrive, and the retirees use them, along with Social Security, to buy groceries and pay rent. They might have investments, but those can be saved for the unexpected, for special occasions, or for the inheritance awaiting their kids and grandkids.
Those days are about to come to an end.
Company after company has repudiated traditional pensions, pushing younger workers into 401(k)-style retirement plans. For diligent savers, a 401(k) can accumulate a big balance, but when the time comes to start using it, things will get a lot more complicated than it was for their parents.
“Eventually these new employees are going to be retiring with a pile of money, and they’re going to need help,” says Bill DeWalt, senior investment consultant at Willis Towers Watson.
Retiring workers have no idea how markets will perform during the rest of their lives. They also don’t know how long they’ll live. A healthy 65-year-old man now has a 25% chance of dying by age 78, but he has the same chance of living to 91 or beyond, according to the Center for Retirement Research. Longevity is increasing, and retirees could end up living far longer than they expect. With a pension, you were paid until you died. With a 401(k), you could come up short.
Spend too little, die young, and you could have been having more fun. Spend too much, live a long time, and you risk running out of money.
The obvious solution is to offer ways for workers to turn the money in their 401(k) into a steady income stream. The Obama administration has changed regulations with the goal of making “lifetime income” a part of retirement plans. In other words, turn that 401(k) into a pension.
This hasn't quite caught on, though. A new survey by Willis Towers shows that less than a quarter of large and midsize employers offer any kind of tool for lifetime income. Those who do generally offer just education and planning tools to help you figure how much is safe to spend. Only about 5% currently offer a guaranteed income as part of their retirement plans.
Workers approaching retirement can, of course, go out and buy themselves an annuity, which is a contract with an insurance company that guarantees a certain amount of income for life. But individuals find this process intimidating and confusing. They can end up paying high fees and have to deal with salespeople who won’t necessarily put their interests first.
There’s also a natural resistance to handing over part of your nest egg to an insurance company, assets you could lose if you die too soon. Despite this, economists argue that an annuity can be the rational choice. For a simple pile of assets to match the income of an annuity (with typical fees), it needs to be 20% larger, according to a recent report from Boston College’s Center for Retirement Research. An especially smart option, the center calculates, is a longevity annuity, a payout that doesn’t start until 80 or 85, when the rest of your nest egg may be depleted and health-care expenses often rise.
Your 401(k) plan could provide better access to these tools, but it probably won't. Complicated regulatory rules make employers think twice. and there are concerns about the difficulty of moving annuities from plan to plan. The government could solve both problems with clearer rules, says Joshua Gotbaum, a Brookings Institution scholar who formerly led the U.S. Pension Benefit Guaranty Corp. But so far, federal agencies and the 401(k) industry haven’t been able to agree on a solution.
Employers are at least thinking more about lifetime income. While only 23% of companies polled by Willis Towers offer a lifetime income tool, another 18% are considering doing so by next year, and another half said, “maybe in the future.” Just 4% of employers said they weren’t interested.
Meanwhile, many 401(k)s are starting to offer managed accounts. These are services offered by such companies as Financial Engines and Morningstar that give advice on how much to spend and where to generate income. These accounts can be set up to send retirees a safe amount of money each month, even if those payouts aren’t guaranteed by an insurance company for life. Managed accounts can also offer advice and can set aside some money, so retirees can buy a longevity annuity with part of their savings.
The trend is toward income products that can be customized to each retiree. “One size does not fit all,” DeWalt says. “One product will not meet everyone’s needs, so people should stop thinking about it that way.”
The traditional pension was a simple solution, at least for workers. The future of retirement may well be a lot more complicated.
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