Retirement Debate Focuses on Annuities

WASHINGTON (TheStreet) -- The steady evaporation of pensions, the asset-sucking sting of the recession and the prospect of Americans living deeper into their retirement years is driving insurers and the government alike to ratchet up a push for annuity products.

According to government projections, married couples have a 47% chance that at least one of them will reach their 90th birthday. In addition to the risk of outliving assets, sharp declines in financial markets and home equity during the last few years and the continued increase in health care costs have intensified workers' concerns about having enough savings and how to best manage retirement savings.

In response, the U.S. Department of Labor is soliciting opinions on whether new legislation or policy is needed to encourage the conversion of 401(k) assets into lifetime income streams through annuities.

Among the companies that has weighed in on the debate is Columbus, Ohio-based insurer Nationwide Financial Services ( NFS), which has launched its own policy initiative, 401KIncome.

Nationwide's 401KIncome proposal promotes 401(k) plans that would offer fixed income-deferred annuities as the investment option for the employer match. Plan sponsors would receive a tax credit instead of a deduction for any employer match used to fund a "guaranteed stream of income payments" to participants. Employees would still have control over and access to their own contributions, but the employer match would not be accessible for loans or early withdrawals. Employees could also choose to put their own deferrals in the defined benefit option.

"Ensuring that small employers have a broader tool set for their employees through a 401(k) plan is really what this proposal is trying to encourage," says Anne Arvia, president of Nationwide Retirement Plans. "It is really trying to create a product that shifts the guaranteed income stream -- which is a scary liability and why the defined benefit plans are moving away -- from the employer to an insurer who is probably better equipped to think about how to manage that risk."

TIAA-CREF, which manages the retirement savings of 3.7 million Americans and has $414 billion in assets under management, has also added its voice to the chorus.

"Most retirement accounts emphasize wealth accumulation, with little thought to how that wealth will translate into retirement income," Chief Executive Roger W. Ferguson Jr. said in a statement.

The company cites a 2009 McKinsey Consumer Retirement Survey that estimated that 60% of 401(k) participants are interested in investment options that provide guaranteed income in retirement. The number of consumers worried about a lack of guaranteed income more than doubled from earlier this decade, according to McKinsey. Among its customers, TIAA-CREF has found that nearly one-third of participants choose to annuitize some portion of their assets.

New York Life Insurance Company is targeting its push for annuities to women. The company says last year it was the nation's top seller of fixed immediate annuities to women, who accounted for 64% of its record $1.9 billion in sales. The company says that women face a potentially longer retirement than men because of their increased life expectancy.

Pros and cons

Last month, the Government Accountability Office released a study that looked at various options for lifetime retirement income and offered insight into the marketplace for annuities. It found that 6% of households owned individual annuities in 2007. Only 3% ($8 billion) of the total amount of annuities sold in 2008 were fixed immediate annuities, designed solely to provide lifetime income. The majority of annuities sold are deferred annuities, which are rarely converted to lifetime income.

Single premium immediate annuities are usually purchased with a lump sum, and payments begin immediately or within one year of the purchase date. Sales of single premium immediate annuities totaled $264 billion in 2008, according to data from Morningstar ( MORN) compiled by the Insured Retirement Institute.

Annuities offering lifetime income typically provide retirees more income than they would receive from more conservative investments, such as bonds, the GAO says. A $100,000 annuity purchased in April would provide an estimated $6,480 per year as long as the purchaser or their spouse is alive, which is 25% more than the $5,200 of income earned from a highly rated 30-year corporate bond at the same price. The drawback is that the principal amount of the bond would typically be available in 30 years, whether or not the purchaser or their spouse is alive.

There are other disadvantages. Many retirees lack the assets needed to buy an annuity that would replace more than a fraction of their preretirement income. Most life annuities may be designed to provide a constant level of income, but the premium is generally not available to cover large unplanned expenses.

Few annuities provide payments adjusted for inflation, the impact of which can be significant. During the past 30 years, inflation has eroded the value of the dollar by 63%.

Annuities generally leave nothing for heirs as payments end upon the death of the holder or, in the case of joint and survivor annuities, a spouse.

Some annuity products attempt to resolve some of these limitations. Some insurers provide opportunities to cancel an annuity for a limited period of time in exchange for lower monthly payments. Annuities are also available with limited death benefits, but offer lower monthly payments to holders.

To provide some protection against inflation, some providers also provide an option to automatically increase monthly payments each year by 2% to 3%.

There are also variable annuities that provide lifetime income based on guaranteed minimum growth in the initial premium, even if the variable annuity balance drops to zero. These varieties have increase expenses. One variable annuity prospectus reviewed by the GAO indicated that maximum expenses for a $10,000 investment and a 5% annual rate of return could exceed $7,000 over a 10-year period.

-- Reported by Joe Mont in Boston.

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