In his recent Forbes article Income as Outcome: Reframing the 401(k) Plan, my friend and research colleague Jeff Brown – a professor at the University of Illinois – argues that more people would enjoy real retirement security if they better understood the real purpose of their defined contribution plans. He rightly decried the extensive degree to which retiring 401(k) participants fail to use “annuities and other guaranteed lifetime income products” as part of their investment strategy. He asserts that more widespread reliance on annuities – especially immediate annuities – to turn 401(k) asset balances into guaranteed lifetime streams of income would enhance the financial security of many retirees.
Why don’t they do it? Jeff believes the main problem is this: as people accumulate for retirement, they are taught to focus on their account balance. But when they retire, stop accumulating assets and have to start living on what they’ve accumulated, they view any product which reduces that account balance – such as immediate annuities, which have no balance – as unattractive.
In Jeff’s view, defined contribution plan participants need to be re-educated. The purpose of a retirement account, he says, is not to take pride in the size of its balance. It’s to help us maintain our standard of living during retirement, however long that retirement may last. Annuities and other guaranteed lifetime income products need to be described differently – “reframed,’ if you will – so that people more easily comprehend their important role in helping retirees maintain spending throughout their lives.
I agree with Jeff’s analysis as far as it goes, but I believe there are some important points he did not address. For instance: almost everyone conceives of guaranteed lifetime income as separate from their asset level. Ask someone already receiving Social Security about the value of their financial assets and they will not mention their guaranteed Social Security payments – even if they are deriving almost all of their income from that source.
The fact is that when someone buys an immediate annuity, the value of their assets does not really go down – a guaranteed income for life certainly has value, and for immediate annuities, that value is easy to calculate. Actuaries do it all the time and call the result “present value.” I submit that if people were regularly informed about the present value of their immediate annuities and Social Security benefits, they would feel more confident and make better financial decisions. They would also have a more accurate measure of their financial health.
I also submit that some financial advisors who are compensated by a percentage of assets under management are reluctant to recommend immediate annuities – because they would receive less compensation but have no less work to do. Showing the present value of an immediate annuity on the client’s statement as part of total assets under management would contribute to more effective use of this product.
The real challenge, though, has been correctly identified by Jeff Brown. Annuities must be presented to defined contribution plan participants, and financial consumers in general, in a way that makes their important position in a retirement strategy clear and attractive. To that end, Greenwald & Associates has, in conjunction with CANNEX, developed a new research program called the Annuitization Attractiveness Index (AAI). It’s designed to accomplish two primary objectives: to stimulate more favorable press attention for these products and to provide financial services companies that sponsor the research with useful insights to help them market to retirees.
The AAI is an annual, online survey of 1,000 retirees that will measure their income needs beyond Social Security, defined contribution income and rental income, as well as how they are drawing or expect to draw needed income. It will also measure their reactions to alternative ways of drawing income, including partial use of deferred income annuities and immediate annuities. These measures will be used to construct the AAI, a single number that will be tracked over time that indicates how attractive respondents consider partial annuitization to be and how attractive annuities are compared to other strategies.
Key survey findings will be released to the media each year. Financial services companies that sponsor the AAI will receive full results and interpretive comments, to help guide product development, marketing and distribution strategies.
For more information about the AAI, email firstname.lastname@example.org.