One in four people living in America today will reach the retirement age of sixty-five in the next twenty years. These retirees must decide—monthly or even weekly, and in the face of ever-longer and ever-sicker life expectancies—how much money to spend to maintain lifetime solvency. Younger workers are not exempt from these pressures: when they retire they will have even larger balances in self-managed accounts such as 401(k) plans, and will need to manage their assets to last throughout an unknowable amount of retirement years.
Several measures would help retirees better manage their assets over time and take advantage of already available, yet underused, financial management tools such as retirement annuities. One approach is that a portion of assets in 401(k) plans or similar accounts could be automatically distributed in the form of consecutive monthly payments for a trial period of two years, unless workers opt out; thereafter, workers could chose to continue receiving annuity-like payments or to receive a lump-sum payment.
This paper proposes a policy that would increase the role of lifetime income products in future retirees’ overall retirement planning. Over the next few decades, a substantial number of workers will retire with larger balances in their retirement accounts and have fewer sources of longevity protection than retirees today. They, therefore, must manage these resources to ensure they last throughout their retirement. Lifetime income products would be beneficial for many because payments are made for life and they mitigate the risk of running out of resources late in life. Despite the benefits of lifetime income, current retirees do not use lifetime income products very much and future retirees are unlikely to do so under current arrangements. The reasons may be that retirees already feel they have sufficient guarantees — for example, from social security benefits — against the risk of outliving their resources. However, evidence suggests also that the market for lifetime income products functions poorly and that people do not understand and are biased against the products.
Our strategy addresses market function by making it easier for a substantial number of retirees to purchase lifetime income plans; the increased volume of sales would reduce prices and make them a better value for the average consumer. Our strategy addresses the role of ignorance and bias by giving retirees an opportunity to “test drive” a lifetime income product, which would help overcome existing biases, reframe their view of lifetime income products and improve their ability to evaluate their retirement distribution option.
Specifically, we propose that a substantial portion of assets in 401(k) and other similar plans be automatically directed (defaulted) into a two-year trial income product when retirees take distributions from their plan, unless they affirmatively choose not to participate. Retirees would receive 24 consecutive monthly payments from the automatic trial income plan. At the end of the trial period, retirees may elect an alternative distribution option or, if they do nothing, be defaulted into a permanent income distribution plan. Employers and plan sponsors would be encouraged to offer the trial income plan and would have discretion over some of its structure and implementation. By making the proposal voluntary, we allow opting out by anyone who is not interested in purchasing guaranteed lifetime income. Several important questions would have to be resolved before this strategy could be implemented. The aim of this paper is to map out the first of several steps toward increasing the use of income products in 401(k)-type plans, with the ultimate goal of enabling improved retirement outcomes for workers.