Morningstar - Q4 2021 - 15

Guaranteed Income
for Retirees
The federal government
still has work to do.
Aron Szapiro
POLICY
As my colleague Jasmin Sethi outlines in the
Spotlight section, and in a longer research paper
she recently published, guaranteed income
provided by various annuity products can help
people achieve better retirement outcomes.
Yet, looking at the state of American definedcontribution
retirement plans, we see that
few people annuitize their assets when they
retire. Sethi's article focuses on ways
advisors can help their clients use annuities
effectively to attain better retirement
outcomes. In this column, I discuss some policy
adjustments-some of which are already
happening-that could help people annuitize.
Most critically, policy should help steer
people toward high-quality guaranteed-income
products that align with their needs.
Congress and the Department of Labor,
which regulates private-sector employer-sponsored
retirement plans, can do some things to
make more annuities available in retirement
plans. However, the lack of lifetime income
options in retirement plans is a hard problem, and
not one that can be easily solved without
a mandate, which is unlikely. Policymakers
need to think about ways to make it easier for
ordinary investors to allocate money to
guaranteed-income products outside their
retirement plans, as well.
The government should design policy to
encourage good annuities, which are uniquely
positioned to help retirement savers and
retirees ensure that they do not run out
of money in retirement. We have some ideas for
how to design it.
Annuity Means Everything and Nothing
First, we need to start with some context on
the annuity market. The term annuity is a problem;
it refers to a staggering array of product
types. Some of these are transparent, simple, and
easy to compare. Most annuity products are
extremely complex, however, and the ones
salespeople try to steer clients to tend to be in the
complex category because such contracts are
more profitable for insurance professionals.
The simplest forms of annuities, known as
single-premium immediate annuities (and their
closely related cousins, deferred-income annuities)
are purchases of a stream of payments until
death for a fixed sum of money. These payment
streams can start today or, in the deferred
case, years in the future.
More complex annuities layer in various forms of
investment risk, downside risk protection,
and guaranteed minimum withdrawal benefits.
Retirement investors, for their part, have largely
recognized the complexities. Annuities do
not have nearly the market share in retirement
accounts that traditional mutual funds do.
Few retirement savers think about allocation
between annuities and other kinds of investments,
at least in part because of the complexity
of annuities and lack of trust in the insurance
industry.
Guaranteed-Income Products Are Uniquely Useful
That confusion is a shame. As Sethi discusses,
vehicles she calls guaranteed-income products
would solve a key income challenge for retirees
that can't be solved with any other available
product. Workers who have saved during their
entire careers risk running out of money in
retirement because they don't know how long they
will need income. Put another way, retirees
don't have enough insurance to protect against
the risk (pleasant though it may be) that they
live an unusually long time.
At best, because they are cognizant of that risk,
many underannuitized Americans are self-insuring
for longevity risk by spending less during
retirement than they should. However, with some
allocation to a guaranteed-income product that
pools their risk of living a long time with that
of others-making sure no one will outlive their
savings-retirees have a greater chance of
experiencing a financially worry-free retirement.
Here's How the Government Can Make It Easier
What is to be done? We hope that at some
point, higher consumer demand for guaranteedincome
products will mean more retirement plans
start offering them. But the government can
take some steps-some of which it's
contemplating right now-to make good annuities
easy to access while perhaps reducing the
proliferation of opaque, expensive, and sometimes
less-than-useful flavors of annuities.
Annuities are typically regulated by state
governments, but there are two big exceptions:
(1) the SEC regulates variable annuities, which
are close enough to securities that they are treated
as such, and (2) the Labor Department regulates
annuities when they appear in certain retirement
accounts, such as 401(k) plans.
Morningstar recommends that the federal
government take the following three actions
for investors:
1 Adjust regulations so employers can include
single-premium immediate and deferred annuities
as default investments.
We do not think that a default annuity structure
is going to be right for all employers or all workers
saving for retirement. However, we believe
that if employers find that most of their workers
would be better off with a guaranteed-income
product, defaulting employees into it makes sense.
As a society, we tend to look back fondly on the
days of defined-benefit plans, and with some
good reason. Workers generally enjoyed knowing
they would have guaranteed income when
they attained retirement age. A default annuity
could allow for a target-date fund or a managed
account to purchase deferred annuities as
workers aged, or otherwise shift some assets into
guaranteed-income products, unless a worker
opted out.
2 Fix some arcane tax laws to make deferred-income
annuities more attractive and easier to access.
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