Should Your Employer Default You Into an Annuity?
Yes--but only if it is a good one.
Congress has been devoting a lot more attention to annuities lately--and with good reason. As discussed in a recent Morningstar paper, some annuities that we call GIPs, or guaranteed income products, fill a role that is sorely lacking in the retirement investment catalog: They supplement Social Security by providing stable streams of income during retirement. With more stable sources of income, retirees can spend money throughout their retirement without worrying that their resources will someday run dry.
With the Secure Act, Congress offered some reassurance that employers would not be liable for putting workers in an annuity with an underwriter that went out of business decades into the future. This was a necessary but insufficient step. The pending Securing a Strong Retirement Act of 2021, commonly known as Secure 2.0, if passed, would further expand the range of eligible annuities in employer-sponsored plans.
Since the coronavirus pandemic, many employers have introduced or expanded financial wellness programs to help their employees cope with increased stress levels caused by precarious economic conditions. Shepherding portions of employees’ retirement portfolios into GIPs is an effective way for employers to take care of their employees’ long-term financial wellness.
Given that annuities should be useful for retirement investors, why have they suffered relatively limited uptake--notwithstanding a mild recent uptick in adoption? The major obstacles discussed in our paper include: lack of availability in employer-sponsored plans and pooled investment vehicles, individuals’ difficulty in assessing “longevity risk” (the risk that retirees’ lifetimes might outlast their savings), confusing or hidden fine print regarding premiums and terms, difficulty comparing products, and irreversibility.
Employers should guide employees around these obstacles by harnessing the resources of their infrastructure. Employers can ease the pain involved in skillfully purchasing quality GIPs by simply defaulting employees into trustworthy products. Employers are better positioned to bargain than most employees so employers can more efficiently pay for the resources necessary to ensure that the GIPs, the only type of annuities that we think are high quality and appropriate for default, are appropriate for employees. If employers are not well-equipped to do this, we have recommendations on that front.
Both the Secure Act and Secure 2.0 incentivize annuitization by allowing larger nontaxable purchases of annuities in retirement accounts. Consequently, more people will likely acquire annuities in their employer-sponsored plans. And they should, as Morningstar has recommended in a recent white paper--provided that the proper safeguards are in place to ensure the annuity is a reliable, high-quality investment. Two key protections would ensure that annuities serve the purpose of providing consistent income over the whole course of retirees’ life spans.
The first key protection is that annuities purchased as qualified default investment alternatives, or QDIAs, should only be GIPs. GIPs begin releasing a stream of payments when a retiree reaches a threshold age, often 65 or 70, and the payments continue until the retiree’s death or for a set period, such as 20 years. GIPs are reliable and straightforward and achieve Congress’ policy goal of enabling individuals to firmly secure their retirements. If Congress mandates that annuities offered as QDIAs must be GIPs, employers will only offer employees annuities that actually provide lifetime income. Employers will thereby shield employees’ retirement portfolios from the plentiful junk annuities on the open market.
The second key protection would be to require vetting of annuity products, especially QDIAs, by a bona fide third-party or other independent evaluating entity. This safeguard would equip beneficiaries with the information they need to accurately assess the quality of the annuity for its cost and in comparison with its peers. Third-party vetting is critical because employers and beneficiaries typically lack the expertise needed to evaluate annuities--especially complex annuities--and employers, though better equipped than individuals, can still be confused or led astray by aggressive insurance agents. Additionally, such vetting cleanses conflicts of interest in cases where an employer stands to benefit--even if indirectly--from defaulting retirement payments into a particular annuity.
Employers should default employees into annuities, but Congress and the Department of Labor must enact more regulations to provide quality control in the marketplace--ensuring that employees are defaulted into only those annuities that will best serve their interests. A better marketplace for annuities would lead to better annuity products. Quality GIPs in defined-contribution plans could help increase happiness during retirement for many individuals.