With 401(k)-type plans, participants are supposed to build up savings through stock market investing during their working years that will then support them during their retirement years. Most people, as is well known by now, for multiple reasons including excessive financial service industry fees, have been unable to accumulate enough savings to support adequate retirements. But even those who are able to build up sizable retirement savings are faced with an additional problem: there are currently no good options for spending down those savings to support them in retirement.
The original idea was that the plans would mimic the defined benefit pensions they replaced. Participants upon retirement would use their accumulated savings to purchase annuities that would support them for the rest of their lives as pensions do.
Life insurance companies and other sellers of annuities use actuarial studies to determine average ages of death. They use these averages to calculate how long they are likely to have to make payments. They calculate the sizes of the promised payments accordingly to make sure that the company on average pays out less than it receives.
An annuity company is a cross between a bank and a casino. The house wins when annuity purchasers live shorter than average; it loses when they live longer.
Annuities, however, have turned out to not be a very good deal for retirees. They are expensive in part because of commissions charged for their purchase, administrative fees, and other forms of costs and profit taking from their corporate issuers.
Annuities are also expensive because of the problem of adverse selection. People are more likely to purchase annuities if they think they are going to live for a long time. Not surprisingly, people who think they are going to live long lives do in fact live longer on average than people who don't. Because of the increased longevity of annuity purchasers, life insurance companies have to set purchase prices higher.
According to a Congressional Budget Office study, about half of the excess cost of commercial annuities comes from the profit needs of the companies that issue them with the other half coming from the adverse selection problem.
By implication, purchasers of annuities could receive significantly more retirement income if they did not have to support the profit needs of companies that sell them. By my calculations, they could receive as much as 20 to 30% more.
There would still be the problem of adverse selection. Nonprofit annuities would pay less than traditional pensions which don't face that problem. But they would pay more than commercial annuities, a significant net gain for retirees.
Currently nonprofit annuities are only available to retirees from employers that have both defined benefit and defined contribution plans. Public school teachers in Connecticut, for example, belong to a pension system that allows them to roll over voluntary supplementary savings to purchase nonprofit annuities to augment their pension checks. Those nonprofit annuities pay out about 25% more than what the same money used to purchase a commercial for profit annuity would.
There are at least two ways to make nonprofit annuities available to the wider public. Social Security could allow people to purchase annuities from its trust fund. In fact, it included that provision in its original 1935 design. Opposition from financial services providers, however, killed the provision.
In the campaign endorsed by Senator Elizabeth Warren, Senator Bernie Sanders, and others to expand Social Security benefits, attention should be paid to allowing the program to issue nonprofit annuities.
Because of the growing retirement crisis, about half of the states are now considering legislation to develop public Individual Retirement Accounts. A number of these would involve pooled funds. Those funds could also be the sources of nonprofit annuities. At retirement, individuals could be allowed to roll their 401(k) balances into the pooled public IRA funds in return for nonprofit life annuities.
Coupled with expanding Social Security benefits, making nonprofit annuities available would go a long way toward alleviating the growing retirement crisis.
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