The federal government is trying to make it easier for workers to buy annuities with their retirement savings. The Treasury Department issued several new regulations last week aimed at encouraging retirement savers to use their 401(k) balance to purchase an annuity that would guarantee monthly payments throughout retirement.
[See How to Take Advantage of New 401(k) Fee Disclosures.]
"Having the ability to choose from expanded options will help retirees and their families achieve both greater value and security," says Treasury Secretary Tim Geithner. Here's a look at how the Treasury's regulations could impact your 401(k) plan.
Partial annuities. One the Treasury's proposals aims to make it simpler for retirees to purchase annuities with some of their retirement savings, while retaining the rest as a lump sum for other purposes. A 2011 Government Accountability Office report found that many middle class households without traditional pension plans would come out ahead by using some of their retirement savings to purchase an annuity.
Consider a couple that has $191,000 saved for retirement who uses half of that balance ($95,000) to purchase an annuity that would provide $355 per month until the death of the last surviving spouse and annual increases for inflation. This immediate annuity provides slightly more money than the annual income provided by a 4 percent draw down strategy, while also protecting the couple from the risks of investment losses and inflation, according to GAO calculations. And by leaving half of their savings outside the annuity, the couple also has money for unexpected expenses or to pass on to heirs.
[See 401(k) and IRA Changes Coming in 2012.]
Annuities also have their drawbacks, including sometimes steep fees and expenses and complicated mechanics. There's also a possibility that an insurance company could default on its obligation to make annuity payments.
Longevity annuities. Another Treasury proposal would make it easier for retirement savers to purchase longevity annuities. Longevity annuities are generally less expensive than immediate annuities because the monthly payments don't start until late in your retirement, perhaps at age 80 or 85, so that you will have money in your later years in case you live that long. "Because longevity annuities typically are purchased at or near retirement, but do not begin paying benefits until considerably later, they can be offered at a fraction of the cost of annuities that pay immediate benefits," according to a report by the Council of Economic Advisers. For example, an annuity for a 65-year-old that offered a guaranteed stream of payments of $20,000 per year beginning immediately might cost $277,500, while a deferred annuity offering the same annual benefits starting at age 85 might cost just $35,200, the report found. "Because the annuity starts far in the future it serves as a kind of insurance so you can enjoy the security of knowing you will have retirement income even if you live far beyond your life expectancy," according to a Treasury official.
Spousal protections. The Treasury clarified rules that require a spouse's consent when a worker elects to purchase a single-life annuity in which payments would end when the worker dies, rather than continuing throughout the lifetime of the surviving spouse.
[See How to Finance Life Until 100.]
Pension plan rollovers. Employees would also be allowed to use their 401(k) plan payout to obtain a low-cost annuity from their employer's traditional pension plan. "If the employer sponsors both a 401(k) and a defined benefit plan the ruling provides an opportunity to roll over or transfer some of the benefit to the defined benefit plan," according to a Treasury official.
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