Brian Allen, CFP®
Founder & Chairman of Pension Consultants, Inc. | Industry Authority | Author
Retirement planners, regulators, and legislators have spoken out in recent years about the need for solutions to this troubling problem: The typical American, when reaching retirement age, doesn’t know how to withdraw funds from their 401(k) in a way to make the money last the rest of their lives.
It’s a serious situation because many retirees worry about outliving their 401(k) savings – and with good reason.
Typically, an immediate annuity is presented as the solution. The annuity pays out like a defined benefit pension plan would – in a monthly amount for the rest of your life (and your spouse’s life if selected). Here’s how this would work with a 401(k): When you hit retirement age, you take the money from your 401(k) account and convert it into a single premium immediate annuity (SPIA). Then you begin to receive a monthly income.
That is what is being talked about in public policy discussions. Regulators are suggesting that someday plan sponsors would have to offer this annuity option to 401(k) plan participants, and Congress is talking about possibly passing laws that would make that a requirement.
But they all should stop a minute and take a deep breath. This isn’t the main difficulty facing working Americans in search of a secure retirement. It’s not even close. The big problem isn’t helping people distribute their retirement assets to last their lifetime. The big problem is getting people to accumulate the assets they’ll need in retirement.
This shouldn’t be news to anyone who follows the retirement industry. Most Americans haven’t saved the money necessary to afford a comfortable retirement. Every few weeks it seems, a survey is released that illustrates this point.
So why all of the fuss over distribution planning, when the real problem is on the front end – contributions? I suspect it’s a lobbying effort from insurance companies. After the Obama administration made a strident push for a new fiduciary rule, commission-heavy annuity sales plummeted. Requiring all 401(k) plans to offer an annuity option at retirement would be manna from heaven for ailing insurance companies.
If we truly want to help the most people, however, we should put more attention on how to get them to make the necessary contributions to their 401(k)s. Automatic enrollment, automatic escalation, and automatic re-enrollment have been big positives in that regard. But much work still needs to be done.
In 2006, the Pension Protection Act provided a safe harbor for automatic saving features, and that has been the biggest innovation in closing this contribution gap. Behavioral finance is the backdrop for its success by switching the default to the desired outcome. That has increased contributions dramatically.
To get workers on track for retirement, though, more work needs to be done. Unfortunately, while more and more plan sponsors have adopted automatic features to their 401(k) plan, too many have done so at too low of a contribution level – often 3%.
If you’re putting in only 3% and the employer is matching 50% of that, you end up with a 4.5% contribution. For the typical American worker, that’s not enough. They need to contribute somewhere between 10 to 20% of their compensation to have an income in retirement that’s equivalent to what they had before retirement.
It depends on your age. If you’re younger, say in your mid-20s, 10% is a good target. But if you don't start contributing until you are in your early to mid-40s, you really should be saving closer to 20% of your income.
If we’re going to make this a public policy issue, industry groups and regulators should provide more education to plan sponsors and plan fiduciary committees about how much people need to save in their 401(k)s. The key is to design automatic features that set the workers on a path to true retirement readiness. For example, enrolling people at 6%, then kicking in an automatic increase of 1% a year, and maxing out at 12 to 15%.
A concerted effort here would be much better public policy than helping people figure out what kind of withdrawals they should make over their retirement.
About Brian Allen CFP®
Brian Allen (www.pension-consultants.com) is the author of Rewarding Retirement: How Fiduciary Committees Can Elevate Workers, Companies, And Communities, and Founder & Chairman of Pension Consultants, Inc., a fee-only plan adviser on a mission to improve the financial security of American workers. Allen has been an advocate for professionalism and a pioneer in the qualified retirement plan industry for more than 25 years. He was an early mover to a business model that eliminates incentives and inducements that can influence recommendations to clients, including commissions, gifts, marketing payments, and exotic trips.
