Back in ancient China, employers (warlords and land barons) were generally more knowledgeable than their employees (serfs) in business and financial matters. These employers believed it was their responsibility to provide financial rewards to long-term loyal employees during their income-producing years as well as during their non-income-producing retirement years. This spawned the birth of defined benefits, also known as guaranteed lifetime income annuities. However, this employer’s traditional sense of responsibility to provide defined benefits began to change in the late 1980s.
In 1985, if an employer promised $1,000 a month at retirement through a defined benefit plan, workers could rest assured they would receive $1,000 per month for the rest of their lives. As in ancient China, the employer took on the interest rate, life expectancy and market risk costs associated with accumulating sufficient assets to pay the promised income for life. However, toward the end of the 1980s, the economic realities of declining interest rates from previous double-digit highs, increasing life expectancy and greater market volatility (the October 1987 market implosion, for example) caused employers to become concerned about controlling the increasing expenses involved with funding defined benefit plans.
The Shift to 401(k) Plans – a Shift in Risk
The shift from defined benefit plans, in which employers took on long-term liabilities, to 401(k) plans, in which plan participants now take on those same liabilities, is actually a major shift in risk. The plan participants are not only responsible for the contribution to their 401(k) accounts, but equally responsible for the amount of income they will have in retirement. Along with bearing the risk of contributing and distributing their participant account assets, they also have market and expense risk associated with their accounts.
So the normal use of employer retirement income funding responsibility established centuries ago in China has now become the abnormal use of a generally inexperienced 401(k) plan participant to fund their own retirement income.
During the late 1980s, many options were reviewed to help the employer manage the promised retirement income cost liability, which was being hammered by lower interest rates, increasing longevity and market volatility. The most touted answer among several options led to the rise of the 401(k) plan. The 401(k) almost, but not completely, eliminated employer fiduciary and cost liability by shifting the burden to the plan participant. Meanwhile, plan participants are doing a less than acceptable job of funding their retirement income needs, according to the President’s Council of Economic Advisors 2012 report, “Supporting Retirement for American Families.”
Neither employers nor lawmakers nor stockbrokers nor plan participants will claim they were the primary cause of the shift from defined benefit plans to 401(k) plans. However, with the possible exception of stockbrokers, who continue to make money, and employers, who believe they have eliminated most of their fiduciary liability, all of them now believe we need to return to defined benefits (a lifetime income annuity). But how?
Currently, two available options allow 401(k) plan participants to convert a major part of their 401(k) account to defined benefit (lifetime income annuity) savings in their account. As we recently witnessed, the Treasury Department has developed a deferred income annuity (DIA) for 401(k) plans. This annuity addresses the issue of living too long, but lacks flexibility in several areas.
Also available is a specially designed fixed index annuity (FIA) with living income benefit rider. Once the FIA is added to the 401(k) plan, participants have the option to move a portion of their savings account balance to this annuity. The FIA is designed to provide more flexibility than the Treasury Department DIA. It can stand alone, or it can complement the longevity annuity if both options are selected by the plan participant.
Some of the flexibility features of the FIA are:
 Market-linked growth – with no risk to principal.
 Access to cash value at all times, before or after income starts.
 The income start date can begin any time after one year and age 55.
 Account value access at death.
 Spousal joint life income payments are available.
 Participants can start contributing to the equity index annuity as early as age 25.
 FIA contributions are not limited to the Treasury DIA lesser amount of 25 percent of the plan participant’s account balance or $125,000.
The 401(k) plan participants who elect both the Treasury DIA and the FIA will have come a long way back to the original intent of retirement income security in ancient China, by converting their 401(k) account to a defined benefit guaranteed lifetime income annuity.
Problem and Solution
However, who will educate the employer and the plan participants about the availability, features, and benefits of the Treasury DIA and the EIA guaranteed lifetime income annuities?
Guarantees are considered the realm of the insurance advisor, who also may be licensed as a securities representative. Insurance advisors are normally trained in the guaranteed features and benefits available with fixed annuities and life insurance. So who better than the insurance advisor to educate the employers and 401(k) participants about the DIA and FIA option available in their plan?
Only 16 percent of 401(k) plans offer some kind of “paycheck for life,” according to a 2012 CNBC report. This leaves 84 percent of 401(k) plans with no type of future guaranteed lifetime income option (defined benefit) DIA or FIA for their plan participants. These 401(k) plan employers will want to make these two valuable benefits available as soon as possible, particularly when they see little or no additional cost from third-party administrators who specialize in administering these types of future guaranteed income options.
Since the Treasury Department has jumped in to help plan participants, shouldn’t we as advisors do the same?