This Won't Solve the Retirement Crisis

Most people have seen their retirement accounts take a wild ride over the past two years. Yet while a recent government initiative seeks to encourage more retirees to take steps to remove some of the volatility from their retirement savings, it ignores the far more important problem -- one that no one will solve as easily.

The proposal
The Treasury and Labor departments announced that they would solicit public comments on how they can encourage workers to move their IRA and 401(k) plan accounts into annuities when they retire. According to recent research, only about 2% of all workers put their 401(k) plans into annuities, instead choosing to receive the retirement benefits in a single lump sum, which they can either spend immediately or roll over into their own individual IRA.

It's reasonable for the government to be concerned about what retirees do with their retirement funds. First, when retirees exhaust their own personal funds, they often rely on government programs like Medicaid, which puts a burden on the state and federal governments that provide their funding. Second, given the public outrage about Wall Street during the financial crisis, restoring some confidence in the ability of financial solutions to bring results for average workers is arguably essential to the smooth running of the financial system.

Talking its own book?
Of course, cynics will argue that the government has another incentive: the big investment it has in American International Group (NYSE: AIG  ) . AIG is one of the top sellers of individual annuities in the U.S., along with MetLife (NYSE: MET  ) and Hartford Financial (NYSE: HIG  ) .

Yet the real profits from encouraging workers to buy annuities might well go to companies that specialize in selling group annuities through employers. ING (NYSE: ING  ) , Prudential (NYSE: PRU  ) , and Manulife Financial (NYSE: MFC  ) are among the top sellers of group annuities, and to the extent that they already have inroads in selling to employees of large employers, they might well succeed in swooping in before individual-annuity salespeople ever get a chance at the $3.6 trillion held in 401(k) plan accounts as of mid-2009.

The measure might also boost prospects for related companies like Aflac (NYSE: AFL  ) , which doesn't specialize in annuities, but could benefit from having workers more frequently exposed to insurance products from their employers.

A nonstarter solution
Regardless of your level of cynicism, you shouldn't harbor any false illusions that annuities would be a panacea for most workers. Although the type of annuity that the government is implicitly recommending has true benefits and can be a valuable part of a retiree's overall portfolio, the idea that annuities can solve everyone's retirement savings problems is ridiculous.

The biggest problem with the proposal is that most workers don't save nearly enough for an annuity to make a measurable contribution to their retirement income. According to Fidelity, the average 401(k) balance was just over $60,000 as of last September. One annuity source provided a quote of $355 per month for a 65-year-old woman buying an immediate annuity with $60,000. Even with shorter life expectancies, men of the same age would get only $379 per month.

Unfortunately, the annuity proposal doesn't address the far more important question: how to build up your 401(k) balance in the first place. Investments with guaranteed payouts have performed relatively well in the past 10 years compared to the stagnant stock market, but it's extremely difficult to accumulate enough wealth in your working years if you invest solely so conservatively. For most people, taking greater risk is a necessity.

The best answer
The key lies in teaching people how to handle their own finances. If workers got the financial education they need in order to invest their 401(k) balances well during their careers, then they'd already have the foundation they need to continue to manage their money after they retire -- and they wouldn't need to rely solely on annuities to keep themselves disciplined.

Seeking to improve retirement for all is a noble goal. But until there's a true commitment to financial education, proposals designed to take decisions out of the hands of the average worker may well end up doing as much harm as good.

Tune into this year's Fiscal Fitness Boot Camp and get some great tips on how to create savings in your budget. It's easy, and the money you save will be well worth the effort!

Fool contributor Dan Caplinger always looks for easy answers but is willing to settle for harder ones. He doesn't own shares of the companies mentioned in this article. Aflac is a Motley Fool Stock Advisor selection. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy has all the answers.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 11, 2010, at 12:21 PM, CommonPaine wrote:

    And this only goes about 1/10 further along the way to solving the retirement dilemma.

    Just as keeping people in their homes and modifying the terms will not solve the housing market problem, this will not solve the retirement problem. They both have a closely related origin which is not being addressed by either "solution".

    The problems both require a better income source. The foreclosure-likely homeowner requires a job. The 401(k) holder requires an income appropriate to his/her productivity and a real pension plan instead of the retirement killer [401(k)].

    Since 1973 productivity and incomes have parted company. What used to be a parallel track has turned into a major and catastrophic wedge. Few workers put much into their 401(k)s because their incomes have not kept up to inflation. At best their incomes have, in general, stagnated. In far too many cases, their incomes have gone into reverse while their productivity has continued to grow impressively. But they have not realized any of that growth.

    The other problem here is with the 401(k) itself. Far too few employers put an appropriate contribution into the plan. Matches are at far too low a percentage. This is not at all surprising because the 401(k) was never intended to provide workers with a retirement plan to which their employers made a significant contribution. It was also never intended to supplement Social Security as much as it was to help destroy it. All employee contributions to a 401(k) are deducted from income for Social Security purposes. In other words for most Americans, the 401(k) is a retirement killer because it has replaced a real retirement income plan that employers wanted out of, namely pension plans.

  • Report this Comment On January 11, 2010, at 7:17 PM, ds10 wrote:

    Annuities provide an excellent vehicle for retirement income. They are essentially a secure long-term investment providing a fixed stream of monthly income (fixed annuity) or a variable monthly income that tracks the current economic climate (variable annuity).

    They are analogous to a reliable pension.

    As the author states, "The biggest problem with the proposal is that most workers don't save nearly enough for an annuity to make a measurable contribution to their retirement income."

    But this is not the fault of the annuity. A savings account of $60,000 at age 65 is unlikely to satisfy retirement no matter what the investment vehicle is.

    With sufficient savings applied, a fixed lifetime annuity can provide a most comfortable retirement. The cost is reasonable, as is the return.

    Don't blame the messenger, blame the message---insufficient savings.

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