Removing the Legal Impediments to Offering Lifetime Annuities in Pension Plans

Source: Jonathan Barry Forman, Pension Research Council Working Paper, WP2016-6, August 2016

from the abstract:
Longevity risk–the risk of outliving one’s retirement savings–is probably the greatest risk facing current and future retirees in the United States. At present, for example, a 65-year-old man has a 50 percent chance of living to age 82 and a 20 percent chance of living to age 89, and a 65-year-old woman has a 50 percent chance of living to age 85 and a 20 percent chance of living to age 92. The joint life expectancy of a 65-year-old couple is even more remarkable: there is a 50 percent chance that at least one 65-year-old spouse will live to age 88 and a 30 percent chance that at least one will live to 92. In short, many individuals and couples will need to plan for the possibility of retirements that can last for 30 years or more.

One of the best ways to protect against longevity risk is by securing a stream of lifetime income with a traditional defined benefit pension plan or a lifetime annuity. Over the years, however, there has been a decided shift away from traditional pensions and towards defined contribution plans that typically distribute benefits in the form of lump sum distributions rather than as lifetime annuities, and people rarely buy annuities in the retail annuity market. All in all, Americans will have longer and longer retirements, yet fewer and fewer retirees will have secure, lifetime income streams.

There are a variety of ways that the federal government could promote greater annuitization of retirement savings. In particular, government policies could be designed to increase retirement savings, for example, by requiring employers without pension plans to at least offer automatic payroll-deduction IRAs to their employees. The government could also encourage workers to remain in the workforce longer, for example, by increasing the early and normal retirement ages associated with Social Security and pensions. Government policies could also be designed to get workers to preserve their retirement savings until retirement, for example, by discouraging premature pension withdrawals and loans.

The federal government could also do more to promote annuitization. One approach would be for the government to mandate that retirees use at least a portion of their retirement savings to purchase annuities or similar lifetime income guarantees. Alternatively, the government might only want to encourage annuitization. For example, the government could require plan sponsors to include annuities or other lifetime income mechanisms in their investment options and/or in their distribution options. The government could also provide additional tax benefits for individuals who receive income from lifetime annuities and lifetime pensions, for example, by completely exempting lifetime income payments from income taxation or favoring them with a reduced tax rate. The federal government could even get into the market of selling annuities. In any event, the government could make it easier for plan sponsors to offer annuities and deferred income annuities, for example, by letting plan sponsors rely on insurance regulators and industry standards to oversee and monitor annuity providers. The government could also promote better financial education about annuities and other lifetime income options.

Finally, in addition to promoting annuities, it could make sense to broaden the range of permissible lifetime income products–especially low-cost products that pool risk among participants, as opposed to products that necessitate high premiums to compensate insurance companies for their guarantees and profits. In that regard, for example, TIAA’s College Retirement Equities Fund (CREF) offers a variety of low-cost variable annuities that pool risk among participants. So-called “defined-ambition plans” like those in operation in the Netherlands offer another way to share risk among plan participants.

All in all, modest changes in the laws and regulations governing pensions and annuities could go a long way towards helping to promote secure, lifetime retirement incomes.