New 401(k) rules issued in July by the Treasury Department may help you avoid outliving your money.
And they may be an answer to one of the irrational retirement choices many of us make that I wrote about last summer. It’s the one known by economists as “the annuity puzzle.”
That's the conundrum (at least to economists) of why employees who are about to retire and are offered pensions tend to take that money as a lump sum rather than an annuity that automatically invests the cash and sends monthly checks that won’t run out.
(MORE: The Most Important Thing to Know About Your 401k)
The Aversion to Annuities
Most 401(k)s don’t offer an annuity option, but some do and more likely will due to the new Treasury rules for longevity annuities, sometimes called deferred-income annuities or longevity insurance. With those, you buy the annuity from an insurer now, but the guaranteed lifetime payments generally don’t start until you’re in your 80s.
In his 2013 research of 5,000 Americans age 50 to 75, John Beshears, an assistant professor of the Harvard Business School, and four co-authors discovered that although older Americans like the idea of a steady income stream in retirement, they hated annuities’ lack of flexibility — especially when they had to take their entire retirement stash either as a lump sum or annuity rather than a little of each.
“Putting all your money in an annuity can feel scary,” Beshears told me. “But if retirees are allowed to keep 50 percent of their money in an annuity, that helps them feel they’ve met their need for flexibility and control.”
Indeed, when survey respondents were given a hypothetical partial annuitization option – taking an annuity for between 25 and 75 percent of their retirement money – 60 percent chose it.
Treasury's New Rules on Longevity Annuities
And that’s where the new Treasury rules for 401(k) annuities come in.
The rules, which take effect immediately, say employees will now be allowed to convert a portion of their 401(k) balances (or IRA balances) into what’s known as a “longevity annuity” that offers guaranteed payouts over your lifetime.
(MORE: Irrational Retirement Choices We Make)
You’d only be able to do this with up to 25 percent of your balance or $125,000, whichever is less to avoid running into the Required Minimum Distribution rules that normally kick in when you’re 70 ½. The new rules exclude this type of annuity from your retirement account balance when determining the minimum amount of retirement-plan money you must withdraw each year starting at 70 ½.
The new rules also say that if you buy one of these annuities and die before the age when they’ll start paying out, the premiums you paid but haven’t received as annuity payments can go to your heirs through what’s known as a “return of premium.”
More Plans May Offer Them
Until now, only about one in five 401(k) plans offered longevity annuities as an option. The new rules could make the plan feature more common, however.
(MORE: Should You Buy Longevity Insurance?)
Forbes’ Ashlea Ebeling says they “won’t really take off” until the Department of Labor finalizes its proposed rule that would require employers to give employees lifetime income statements, showing how much their 401(k) funds would pay out over time. I wrote about this rule in another Next Avenue post.
If you work for an employer with a 401(k), here’s hoping you’ll soon be offered the longevity annuity option in case you’d like it.
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- How Annuities Protect Against Longevity Risk
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