PROspective Vol I No III March 2010

Chuck Miller: There’s growing sentiment that 401(k)s aren’t working for participants. Is that primarily due to poor participation, investment decisions, saving behavior, or all of them?

Anna Rappaport: I do not agree that 401(k)s are not working. This is a topic on which there are diverse opinions because the plans serve different purposes. I believe that the ideal system from the participant perspective is a base layer of retirement benefits paid for by the employer and supplemented by a 401(k).  However, a 401(k)-only plan can also work well if enough funds are put into the plan and there are good investment decisions.

I also want to add that I see the employer as playing an important role in the retirement system. People save much more when they are enrolled in employer-sponsored plans.

Some plans work well and others don’t. Some work well for certain participants and not others, but no plan will work well for any participants unless they save sufficiently.  

CM: The “fix” for 401(k)s seems to be making them more like defined benefit plans… automatic enrollment, target retirement date funds or managed accounts, etc. Is this a good trend and what other DB-like features could be in the future of 401(k)s?

AR: I think these are good trends. I would like to see more focus on the payout period so that plans focus on making money last a lifetime.  When plans represent the only retirement source of income in addition to Social Security, we need more focus on how plans act as a retirement vehicle.

Where plans are supplemental and there is a good base of guaranteed lifetime income, I see no problem in simply letting participants choose what they want to do with their 401(k) money.

I would like to recommend a resource where one can find more ideas about system-wide solutions for retirement.  The Society of Actuaries Retirement 20/20 project will soon be publishing several papers with ideas for new retirement models.
 
CM: One way 401(k)s may become more like DB plans is the purchase of annuities for guaranteed retirement income. Would they be good for participants and what are the pros and cons of incorporating them into 401(k) plans?

AR: This is not an easy question. Purchasing an annuity can be very beneficial for some plan participants and not for others. There are trade-offs involved in the purchase of guaranteed life income, and it may be the best solution in certain situations, but a terrible option in others.

The primary trade-offs are guaranteed lifetime income versus liquidity, and personal investment management versus delegated investment management. 

When purchasing lifetime income is the best choice, the question is how much guaranteed income should be obtained and what the total portfolio should look like.  Another question is timing and whether purchases should be spread over time. In addition it is important to consider who to buy from and how one ensures a good deal with a sound company.

Guaranteed lifetime income can be very expensive, and depending on the annuity pricing, annuities may not be a good deal.  Purchasing annuities also leads to loss of flexibility, unless the annuity includes provisions for some liquidity (which in turn has a price).

There are different ways to purchase guaranteed life income. A good place to start for many people is taking Social Security at a later age. Annuities can be purchased starting at retirement age or they can be deferred to a later age like 85, serving as so-called longevity insurance.  Using a combination of a managed account with an installment payout to age 85 and longevity insurance offers a way to provide both guaranteed income and considerable liquidity.

A good resource for individuals contemplating whether to buy an annuity is “Making Your Money Last a Lifetime: Why You Need to Know About Annuities,” a joint publication of the Women’s Institute for a Secure Retirement and The Actuarial Foundation.

CM: You were just named to the ERISA Advisory Council as its actuarial representative. What is your role on the Council?

AR: As a member of the Council, I help provide advice to the Secretary of Labor and assist with her ERISA-related duties. I bring to the Council my knowledge of the retirement system and my unique perspective as an actuary. I will not speak publicly for the Council as the Chair is the only member of the Council who publicly speaks on its behalf. So all of the opinions expressed are my personal opinion and not that of any organization or group.

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