We’ve written a lot on this blog about how 401(k)s and other defined contribution plans fail to provide adequate retirement savings for most working people. There is now plenty of evidence that most workers will not save anywhere close to the recommended amount needed to retire securely. Even if workers do manage to save a substantial amount in their 401(k), are they able to make the money last in retirement? This is a question that is less frequently discussed, but is very important.
According to a recent survey by TIAA, 61 percent of Americans worry about outliving their savings and 68 percent worry that they will not save enough for retirement. That worry is a legitimate one. Let’s consider the hypothetical example of a worker retiring today at age 65 who has saved $500,000 in a 401(k), far above the national average. The average life expectancy in the United States is 78 years, so this retiring worker needs to plan how to spend that $500,000 over the course of 13 years. However, it’s just as likely that this worker could die earlier than expected and leave a large amount of money unspent or could live another 15 or 20 years and outlive their savings.
One option for workers who save in a 401(k) is to purchase an annuity, which does provide a guaranteed monthly income in retirement. Annuities are a very underutilized resource. According to TIAA, only half of working Americans are familiar with annuities and few have actually purchased an annuity in preparation for retirement. There are behavioral barriers that prevent more people from purchasing annuities. One major issue is how to appropriately price the annuity so that what a worker pays to purchase the annuity actually results in a fair monthly income during retirement. Some have proposed allowing Social Security to sell lifetime annuities, which workers would be able to purchase with their 401(k) savings. This is an idea that was actually included in the original Social Security proposal, but was removed during the legislative process.
Defined benefit pensions provide a guaranteed monthly income during retirement. They avoid the problem created by 401(k) plans because defined benefit pensions are a superior plan design. Pensions collectively pool the contributions of employers and workers and then pay out benefits to individual workers as they retire. The actuaries who work for pension plans make projections of how long workers will live so that pensions can plan how much they will need to pay benefits whether an individual retiree lives for 13 years or 30 years after retirement.
Working people want access to guaranteed income in retirement. TIAA found that more than half of active workers say their top goal in retirement is to guarantee enough monthly income to cover their expenses. As policymakers discuss potential solutions to the retirement savings crisis, it is important to remember that one of the strongest features of defined benefit pensions is the guarantee of monthly income in retirement, a feature that is highly valued by working people.