Congress Wants to Make Your 401(k) More Like a Pension. Here's the Problem With That
Do you wish you could transform part of your 401(k) into a pension?
A bill making its way through Congress promises to make it easier to do just that. While that's largely good news, there are still risks, according to retirement experts. Unless additional investor protections are added to the bill, retirement savers could be exposed to costly and opaque insurance products, plus concerns about insurance companies' financial health.
Last month the House passed the Secure Act, touted as the biggest overhaul of America's retirement system since 2006, with overwhelming bi-partisan support. While the bill recently hit a delay in the Senate, leaders from both sides of the aisle support it. The bill aims to improve retirement plans in a number of ways, and one of the biggest changes is to make it easier for 401(k) plans to offer annuities.
How the Secure Act Works
Most 401(k)s are built around stocks, bonds and mutual funds. Those are great vehicles when you're saving and building wealth. But they can be tricky when it comes to time to retire, and you have to figure out how much of your holdings you can safely sell each year to fund a retirement that may last 30 years or longer.
As a result, many economists and retirement experts have encouraged more investors to buy annuities. At its most basic, that means handing all or a significant chunk of your retirement portfolio to an insurance company that cuts you a monthly check as long as you live, much like the vaunted corporate pensions many American workers could count on in the 1960s and 1970s.
"It's putting the pension back in the private pension system," says Mark Iwry, who was in charge of national retirement policy while serving at the Treasury Department in the Clinton and Obama administrations.
While investors can currently shop for annuities on their own, or with the help of a financial advisor, few 401(k)s offer them. Legal experts say that's because employers are afraid they would get sued if the insurance companies that sold annuities to their employees ever became insolvent. The new law aims to address this problem, giving employers what amounts to a legal free pass if they pick an insurer whose financial health eventually weakens.
For consumers, this change represents a trade-off. No one likes to think that they might lose their right to sue when things go wrong. At the same time, there are some big potential benefits to encouraging 401(k) plans to offer annuities. That's especially true at large employers where 401(k)s are overseen by sophisticated committees with access to professional advice, and where economies of scale can lead to lower wholesale prices. Research has shown that income annuities can improve retirees' well being in later life, giving them peace of mind along with a guaranteed income stream.
How to Make the Secure Act Better
But even if this trade-off makes sense in theory, some investor advocates say the free-pass could be tailored much more narrowly and still give investors most, if not all, of the benefits. Here's what they'd like to see in the final legislation:
*The Secure Act offers employers legal protections for offering annuities from any insurer that is in good standing with its state insurance department and has been licensed for seven years. But the law doesn’t require insurers to meet any particular standard for financial health. While Iwry strongly supports the bill, he says both employers and retirees would be better protected if the selected insurers also had to meet a high standard of financial strength set by expert third parties such as rating agencies. No one thinks rating agencies are perfect, says Iwry. But he adds: "It's far better than no financial strength standard."
*While employers will get a legal free pass if insurers get into financial trouble, they will still be on the hook to vet the types and prices of annuities their 401(k)s offer workers. That's a big responsibility, and some experts say the law should make employers' job easier by prohibiting the costliest and most complicated annuities from being included in plans. While simple income annuities that promise a monthly check in exchange for a lump sum are popular with retirement experts, more complicated versions with returns tied to stock market indexes are typically not. In fact, these flavors of annuities, which go by names like "variable" and "fixed indexed" annuities, are famously expensive and difficult.
While nothing in the new law specifically encourages employers to add these more complicated products to plans, consumer advocates including Barbara Roper of the Consumer Federation of America think that they are likely to become more common in plans at smaller companies where investment committees may not have the time and expertise to vet insurance companies' sales pitches. Congress should tweak the proposed law so that so-called legal safe harbor doesn't apply to the sales of these products. Otherwise, according to Roper, "there is a real concern investors will see their retirement savings eroded by these products' high costs."