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Retirement Plans Are Being Reconsidered

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(In the 10th paragraph, corrects the name of the company to Financial Engines, from Retirement Engines.)

By Linda Stern

WASHINGTON, Feb 29 (Reuters) - Will the baby boomers be the only generation to retire with 401(k) plans? It could happen.

Last week many of the nation's biggest thinkers on retirement got together in a Senate hearing room to discuss the future of pensions and retirement. There were representatives of unions, employers, financial services providers, government agencies and consumer groups. And the only thing they all seemed to agree on was this: The 401(k) plan has been sort of a failure.

Those are strong words, and probably overstate the case. Current and future retirees now have some $4.3 trillion for retirement that wouldn't be there if it weren't for their 401(k) and other defined contribution accounts, so it's hard to declare them a complete failure.

But policymakers are now looking beyond the once-vaunted 401(k) because it has two significant shortcomings:(1) It's not powerful enough to secure the retirements of low-income workers who can't afford to stash away enough money; and (2) It leaves each accountholder alone to manage risks. Without being able to pool risk, participants have to settle for lower returns and lower withdrawals.

That cuts the amount that they can spend in retirement, and reduces the likelihood that their money will last until they die.

There is one other reason that retirement analysts are rethinking the 401(k). Financial services firms -- the mutual funds, insurance companies and investment managers who currently are holding that $4.3 trillion for the nation's workers -- don't want to hand it over when the baby boom generation asks for its cash.

There are a lot of proposals and products floating around now that are designed to address these shortcomings and issues. The Obama Administration is trying to encourage workers to think about products (like insurance policies and other investment vehicles) that could guarantee workers lifetime income.

One type of policy proposal would divert 401(k) funding (either prospectively, or, in some cases, using existing assets) to buy into more pension-like plans. Hank Kim of the National Conference on Public Employee Retirement Systems is proposing that states, already used to running efficient pension plans, could run private pensions for small employers. Plans advanced by a broad spectrum of experts, including Teresa Ghilarducci of the New School for Social Research, C. Eugene Steuerle of the Urban Institute and Richard Shea of Covington & Burling, would compel employees and employers to put money towards pension-like guaranteed plans.

Already in the market are products designed to convert existing 401(k) balances into lifetime money streams, and those products are coming on strong. Subsidiaries of insurers like Prudential Financial Inc and ING Groep NV are offering hybrid products within 401(k) plans that seem like annuities but offer greater freedoms: Both will guarantee lifetime income off of 401(k) assets for a 1 percent annual fee, but participants get some growth and can change their minds and withdraw assets at any time.

Other investment companies, like Vanguard, offer mutual funds that will automate distributions (though not guarantee lifetime income) for investors. Financial Engines, an independent advisory company, offers a retirement income program through 401(k) plans that is designed to last a lifetime, though it stops short of that guarantee.

Anyone under the age of 50 should watch that space; policy changes down the road could change the shape of their retirement savings significantly, and everything from a curtailing of 401(k) tax breaks to new state-run programs is under consideration somewhere, by somebody.

But people over the age of 50 should devote extra care to watching these developments. Baby boomers who spent their careers building up those 401(k) accounts aren't going to catch the next wave of retirement plans; they're going to have to live on their savings. Here's a bit of advice for them.

-- Make compromises. If you put all of your money into some kind of guaranteed-for-life product, you typically lock in low returns and you often lose the ability to get your money back. If you keep all of your money invested for growth and pull out withdrawals on your own, you could run out of it before you die. But if you annuitize just a portion of your money, you are free to invest the rest more aggressively.

-- You don't have to rush. Everyone keeps telling boomers that they will probably have retirements that last for decades, so there's no need to panic and lock up your money in some kind of super-safe, super-low-yielding instrument on the first day of your retirement. The older you are when you buy a lifetime product, the bigger the monthly benefits.

Furthermore, money locked away now in annuities is not going to get top dollar returns because interest rates are comparatively low. You can buy a little now and a little later, or just wait until later. Another reason to do that? Products are improving, with more benefits and lower fees. It's sort of like buying a flat screen and then being sorry you didn't wait.

-- Prepare to pay. The idea of guaranteed lifetime income is nice, but it's not free. When you turn your assets over to an insurance company for a lifetime annuity, you give up the cash forever. Even if you go for one of the relatively new hybrid products, there are fees. The Prudential and ING products each charge 1 percent of assets a year for the guarantee -- not counting the investment management fees for the funds in their plans. And the more complicated a product is, the harder it is to unpack. If you're looking at a hybrid, consider: (1) how you can get your money back; and: (2) how much are the underlying fund fees; (3) how much lifetime income are you promised; (4) how solid is the guarantee; and (4) what are your total all-in costs?

-- You always have options. The financial services world is large and competitive, and there's no law that says you have to keep your money in your 401(k) forever. When you retire, you can roll it over into a private individual retirement account at an independent firm like Vanguard or Charles Schwab Corp or eTrade or Fidelity. That opens up a universe of insurance and investment products that could help take you all the way to 100 and beyond. Research carefully; without the 401(k) wrapper, you may not get bargain-priced institutional products that can save you money. But the new products to come, and all the competition, should take care of that. (The Stern Advice column appears weekly, and at additional times as warranted. Linda Stern can be reached at linda.stern@thomsonreuters.com; She tweets at http://www.twitter.com/lindastern.; Read more of her work at http://blogs.reuters.com/linda-stern; Editing by Gerald E. McCormick)