My father died last year—just after Father's Day. He spent his last two years in an assisted-care facility. I learned a lot from those years. It changed my thoughts about 401(k) plans.
Our current attitude about retirement and 401(k)s seems to be that, when an employee retires, he will roll his money into an IRA and manage it in a way that the income lasts until he dies, regardless of whether it is at age 70 or 100. However, that might be wishful thinking.
Even though my father was an accountant, he was in no condition to manage his money over the last years of his life, partially because he slept 12 to 18 hours a day and partially because he floated in and out of being the best that he had been. Because of that experience, I now realize that people need more help with their retirement investments and income. In fact, I now believe that retirement benefits need to be paid, for most Americans, as a guaranteed monthly benefit for life.
However, as an ERISA attorney, I know there is not an obligation for plan sponsors to educate employees about how to use their 401(k) benefits in retirement. Also, there is not any obligation, other than the joint-and-survivor annuity rules (which apply to only some 401(k) plans), to provide a distribution form that guarantees income for life.
That raises a fundamental question: Will your decisions be based on the law's requirements, or do you, as a person who advises or manages a 401(k) plan, work with a higher set of standards? Will plan sponsors adopt best practices to help their employees, or is it necessary for Congress to impose that requirement?
I am aware of two options for concerned plan sponsors. The first is to offer traditional annuities. The second is to offer a relatively new feature called guaranteed minimum withdrawal benefits (GMWB) or guaranteed income for life (GIFL).
A GMWB typically guarantees 5% per year of the "benefit base" for the life of the participant; however, if the participant's account grows, the benefit base goes up. For example, for a $300,000 account, the participant could withdraw $15,000 per year. If the account balance grew to $400,000, the benefit base would be reset and the 5% withdrawals would increase to $20,000.
To buy the guarantee, a participant typically pays a small annual fee. However, unlike an annuity, the participant doesn’t give up his account. Instead, the participant keeps his account balance (in the plan or in an IRA). In fact, it is more like insurance than an annuity—if the participant runs out of money, the insurance company will make payments of 5% of the highest benefit base.
There are some important things I should explain at this point:
- The guarantees are more flexible than I described. If the participant wants to take more than 5%, he can; the difference reduces the benefit base.
- If 5% sounds like a small amount to withdraw each year, it isn’t. Industry and academic studies show that, if a participant wants more than a 10% chance of his account lasting for a lifetime, he can take out only 4% (adjusted for inflation each year).
- If the participant changes his mind, he can stop paying for the guarantee and he still has his account balance—and he can leave his account balance to his family.
Those features are different from annuities in the following ways:
- With an annuity, the withdrawals are fixed; there is no opportunity to take out more when extra money is needed.
- A life annuity makes payments for the life of the retiree—regardless of whether it is one year or 40 years but, when the retiree dies, there is no money left for the retiree’s family. The 401(k) industry is inventing exciting new products and services to meet the needs of plan sponsors and participants. I recommend that you have an agenda item for your committee meetings for "Discussions of New Services and Products." Last, go beyond what the law requires—apply best practices. Your employees will appreciate it, and you can take pride in a job well done.
Disclaimer Required by IRS Rules of Practice:
Any discussion of tax matters contained herein is not intended or written to be used, and cannot be used, for the purpose of avoiding any penalties that may be imposed under Federal tax laws.