Should Your 401(k) Default You Into An Automatic Annuity? Why That’s A Problem In The Year 2022

It’s a simple bill, and a short one, too: The Lifetime Income for Employees Act, or the LIFE Act, introduced back in mid-February as HR 6746, has one objective: to enable employers to default their employees’ 401(k) investments not just in the (by now) traditional “target date” funds but also in annuity contracts. Specifically, for any employer who chooses to do so, the legislation would permit them to automatically allocate as much as 50% of an employee’s contributions to an annuity contract, as long as the employee is able to transfer those investments out again within 180 of the contribution.

As CNBC explained in a March 9 article,

“The bipartisan bill, called the Lifetime Income for Employees Act, also is included in a draft version of another retirement-related bill that is expected to be formally introduced later this month. It is among the handful of measures pending in Congress that seek to build on the Secure Act, legislation enacted in 2019 that aimed to increase both the ranks of savers and retirement security.

“It’s uncertain whether the proposal to let annuities be a default option will make it into any broader retirement bill that supporters hope will be considered this year.”

That same article also quoted Dan Zielinski, a spokesperson for the Insured Retirement Industry, an annuity trade group,

“What we’re advocating is introducing the idea of lifetime income to be at least part of a [default investment option] — not the entire amount, but a portion . . .

“People have anxiety about running out of money in retirement, so this would be an option to alleviate that anxiety and give them a stream of income … while still retaining the other portion of their investment savings.”

Now, I’m all for retirees converting a portion of their assets into annuities to protect themselves against outliving their assets — but this bill would go further: it is not about those conversions but about ongoing investments into deferred annuity products during one’s working lifetime. As a reminder, deferred annuities are an investment product that made some sense in the era before the 401(k) because it offered that same tax-deferral that a 401(k) provides, albeit with a substantial cost in terms of fees and surrender charges. In the year 2022, it makes no sense whatsoever to use deferred annuities rather than purchasing an annuity at the time of retirement when you are ready to buy that long-lifespan asset protection.

Of course, this provision is unlikely to go anywhere, and even if it did, it’s hard to imagine an employer choosing this for their employees, so it’s easy to write this off. But there are real issues around investment decisions and, indeed, around available investment choices for Americans nearing retirement. A traditional annuity ought to be a viable option for them — but isn’t, in part because of the very low interest rates older Americans are facing. After all, annuity providers, in order to make their guarantees, invest in bonds and other safe investments; when those interest rates are low, it drives up the cost of annuities.

Readers may recall that back in early January I wrote that the actual asset allocations for retirees appeared to be riskier than experts recommend, and that it’s hard to blame them for this when bond rates have cratered so much, leaving retirees with little choice if they want to maintain the same expectation for asset returns. And back in November, I wrote a bit of a history lesson, going back to the Japanese response to their experience with low bond rates, beginning in the 90s, when household investors sought out high-risk bonds and currency trading in response.

Now, it turns out, Americans are considering their own high-risk investment in response to low interest rates — or at least the Department of Labor is concerned that may happen and issued a warning: “In recent months, some financial services firms have begun marketing investments in cryptocurrencies as potential investment options for participants in 401(k)s. . . . [A newly-issued DOL] release cautions plan fiduciaries to exercise extreme care before they consider adding a cryptocurrency option to a 401(k) plan’s investment menu for plan participants.” For more on this point, my colleague at Forbes, Erik Sherman, points out the reasons why cryptocurrency is not suitable as a retirement investment (though I suppose I’ll have to point out to him that he gets his 401(k) history wrong).

And at the same time, last week, NBC News reported, “Biden takes big step toward government-backed digital currency.” Now, I don’t hold myself out as an expert on a digital currency; I can be persuaded both that the benefits would be substantial and that the risks to civil liberties are significant as well. But what caught my I were the comments by David Yermack, chair of the New York University finance department.

“In addition to the consumer benefits, a U.S. digital currency would offer the Fed a new tool that economists have previously only theorized about: negative interest rates.

“Controlling interest rates is the Fed’s primary way to stimulate or cool the economy — but it comes with limits. Banks can drop interest rates on regular money only so low, known as the zero bound, leaving central banks with few options when interest rates are already low and the economy needs a boost.

“With a digital currency, the zero bound does not exist, allowing for aggressive action when needed.

“’If the cash is electronic, the government can just erase 2 percent of your money every year,’ Yermack said. ‘I think this is going to become a necessity just because of the demographic changes in the world.’

How can Americans in or approaching retirement, who are reaching the age when experts tell them to invest in less-risky assets, respond to the perpetually-low interest rates — especially in circumstances such as those we now face in which they are paired with high inflation? It seems absurd — yet this is indeed our reality, and I start to wonder whether the scant attention given this issue is because so many experts have simply convinced themselves, with their worries about Americans’ insufficient retirement savings, that this issue doesn’t exist.

As always, you’re invited to comment at JaneTheActuary.com!