What Could Help Americans Manage Their Retirement Money
An idea to turn 401(k)s into automatic, flexible retirement income
You probably think that many Americans fear running out of money in retirement due to a lack of savings. While that’s undoubtedly true, there’s another reason for this worry: Many don’t know how to determine how much of their retirement funds they can afford to withdraw each year.
In fact, in a 2019 survey by the National Institute on Retirement Security, 73% of Americans said they don’t have the financial skills to manage their money in retirement and 79% of retirees said they lacked the investment skills to ensure their retirement savings last throughout retirement.
“Most people don’t know what to do” about retirement savings withdrawals, says David John, a senior fellow at the Brookings Institution think tank and a senior policy adviser at the AARP Public Policy Institute.
"Choosing the best way to convert retirement savings into a stream of income is one of the most complex financial decisions individuals have to make."
An Idea to Create Automatic and Flexible Retirement Income
That’s why John and three Brookings colleagues just came out with a report describing their new retirement income proposal to help people convert retirement account balances into what they call “automatic and flexible” income. Its goal: to be simple, transparent, inexpensive and protect people against the risk of outliving their savings.
As they wrote in their report, “Choosing the best way to convert retirement savings into a stream of income is one of the most complex financial decisions individuals have to make.”
Their three-pronged idea for automatic retirement income would need regulatory, and possibly legislative, approval as well as buy-in from employers. But it seems so smart and could be so valuable to so many retirees that I wanted to share how it could work, with hopes that the solution will become reality.
“We wanted something that would make the decisions individuals would have to make, but does it by using financial professionals, rather than guesswork, blogs and the advice of their neighbors,” said John.
3 Features in the Brookings Researchers' Proposal
The proposal by John and Brookings’ William Gale, J. Mark Iwry and Aaron Krupkin would have three features:
- Something called a pooled managed payout fund
- Another fund that retirees could use to withdraw money for emergencies and other special purposes
- A longevity annuity
I’ll take those one at a time.
A pooled managed payout fund. You may be familiar with target date funds, often offered by 401(k) plans, where you pick your anticipated retirement year and the fund manager invests in stocks and bonds accordingly. When you’re years from retirement, the fund loads up on stocks (because you have time to rebound from market dips). As retirement nears, the fund tilts toward conservative bonds with steady income. Well, a pooled managed payout fund is kind of like that, but for your years in retirement.
A pooled managed payout fund is a diversified, professionally managed pool of investments designed to pay out a relatively consistent level of annual income in retirement through monthly or quarterly cash distributions. The income isn’t guaranteed, but the fund is designed to reduce losses through consistent investment returns and maybe some growth over time.
The Brookings researchers’ plan would automatically enroll employees in the pooled managed payout fund. And the fund could accept cash from retirement plans of employees’ previous employers, their rollover Individual Retirement Accounts and their own IRAs.
There are a few such funds, like the Vanguard Managed Payout Fund. But, John said, “they tend to be very small comparatively” and sold to individuals, rather than offered to employees.
The Brookings analysts say the Vanguard fund aims to pay investors an amount equal to about 4% of their annual assets. That 4% figure is the benchmark financial advisers often use for the amount people can safely withdraw from their retirement funds annually without running out of money.
A fund setting aside about 10% of the money in the managed payout fund for withdrawals to cover emergencies or other special purposes. The Brookings researchers note in their report that JP Morgan Chase Institute studies show that older households are “more likely to have extraordinary expenditures for healthcare, auto repair, and taxes than younger families. Typically, when employers let their retirees take their retirement funds as annuities with regular income payouts, they don’t allow for extra withdrawals when emergencies arise.
“We wanted to come up with something that was flexible enough so when people arrived at retirement and found that what they initially planned wasn’t effective, they could change it” with emergency-fund withdrawals, said John.
A longevity annuity. With most annuities, known as immediate annuities, you hand over a chunk of money to an insurance company and it then invests the cash, sending you monthly income for life. Those payouts either start immediately or soon after you buy the annuity. But with a longevity annuity, sometimes called a deferred-income annuity, you typically give the insurer a lump of cash and the payouts begin once you’re 85 or so, continuing for the rest of your life.
In exchange for delaying receiving money, the longevity annuity’s monthly payments are higher than with an immediate annuity. If you die before the money begins rolling out, your beneficiary typically receives a death benefit or a guaranteed number of reduced monthly payments.
The Brookings analysts’ plan calls for a deferred annuity that starts roughly 20 years after retirement. It’s the “safety net” portion of their idea, to help ensure retirees don’t outlive their savings. Currently, only about 10% of 401(k) plans offer annuities as a retirement income option, although Congress is considering legislation to make annuities more widespread.
What's Happening in Other Countries
John and his colleagues note that versions of their idea exist in other parts of the world or are being considered.
For instance, they note, the Shell Netherlands company has a managed payout fund for employees hired since July 1, 2013. Retirees can buy annuities with the money when they leave their jobs.
The United Kingdom’s National Employment Savings Trust (NEST) — a pension provider set up by the government for U.K. employers — is looking into a proposal similar to the Brookings’ one. It would combine a managed payout pool (90% of a saver’s retirement assets), the ability to take partial payouts for emergencies and other reasons (the other 10%) and protection against longevity risk. People would get monthly income payouts between about age 65 and 85 and could buy deferred annuities after age 75.
Australia is developing the Comprehensive Income Products for Retirees — similar to NEST’s — which would be offered to all retirees starting in 2022.
What Would Need to Happen Here
The Brookings researchers’ proposal isn’t quite ready for prime-time, though.
For one thing, many 401(k)s only let retirees take their money entirely as lump-sum distributions.
For another, it’s unclear employers can offer managed payout funds and annuities as “default investment alternatives” without running afoul of the federal pension law known as ERISA.
“We talked to three ERISA attorneys and got three different responses,” said John. “One said our plan would be absolutely allowed. Another said, ‘I think so, I’m not a hundred percent certain.’ And the other said ‘I don’t think so.’”
The Brookings report's authors are urging the U.S. Department of Labor to amend its regulations to eliminate any concerns.
And they think time is of the essence, since increasing numbers of boomers are retiring with 401(k)s each year and little idea how to manage the money.
“We see very few employers actually offering a retirement income solution,” said John. “As we go forward, we will have more and more people retiring on a combination of Social Security and savings and it’s frightfully easy to make a bad decision if someone gives you a lump sum and you have no practical experience investing.”