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Should 401(k)s include annuities?

By Jennie L. Phipps ·
Wednesday, September 15, 2010
Posted: 3 pm ET

Insurers are pushing hard for the inclusion of annuities in employer-sponsored retirement plans. This week, representatives from all the largest insurance and other financial service companies are testifying before  the Labor and Treasury departments on whether new laws should encourage an annuity option in 401(k)s.

Spokesmen for MetLife and Prudential Financial made the case that workers need some way to guarantee income for life in their retirement planning now that most people don't get pensions, and they pointed to their annuities as the best available option.

A skeptic might point out that one of the big reasons that insurance companies love annuities is that most of them come with a 7 percent to 10 percent upfront sales commission, plus 2 percent to 3 percent annual fees, and a substantial penalty if you want to get out of the annuity plan.

Both Vanguard Group and Fidelity Investments made the most sensible arguments yesterday, pointing out that most people who buy annuities do so when they are almost 70 years old, so putting them in 401(k)s during their work life is premature. Vanguard urged government support for making rolling over a 401(k) into an annuity a simpler process.

Employers have loathed to include anything in defined contribution plans like 401(k)s that might be construed as a guaranteed outcome, so unless Congress inserts some kind of hold-harmless clause in any legislation that adds a guaranteed income option to 401(k)s, companies aren't going to like it.

Since last December, there's been a bill pending in the Senate, introduced by Sens. Jeff Bingaman, a New Mexico Democrat, Johnny Isakson, a Georgia Republican, and Herb Kohl, a Wisconsin Democrat, that would require corporate retirement-plan sponsors to tell participants how much monthly income their 401(k)s would generate in retirement. While the calculation seems like it could easily be meaningless, it certainly would be eye-opening for people to realize that the average 401(k) balance according to Fidelity is only $66,900. That amount, calculates, would at age 70 generate a single woman a measly $452 per month or $5,424 per year. A couple can expect $398 per month or $4,476 per year.

All the retirement planning regulation in the world can't save us if we don't save ourselves.

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1 Comment
End the Ponzi Scheme
September 17, 2010 at 9:39 am

Run the numbers, you'll see why the annuity has no place.

Life expectancy of 70 female from an actuarial life table: 15.9

Your heirs get nothing back when you die, so the $66,900 is gone once you buy in.

Based on the payment of $5,424 a year, we need to make 8.1% annually to not even touch the principal. Looking at a list of mutual funds which average over 5% annual returns, there are 1069 to pick from, most being long term bond funds, but there are some equity funds in the list, and 266 of them meet our need of >8.1%.

So, if I took that 66,900 and put it in one of these nearly 200 funds, especially one of the 266 funds, not only do I not even touch the principle, the underlying fund balance starts growing, so I can take an increasing distribution in the future to account for inflation, which the annuity does not.

Lets look if I only do half as well, and get 4%, which long term CD rates were there not long ago, and once inflation kicks in again, it'll be right back there again. As a note, multiple state muni bond funds easily clear 4%, some as high as 5.5%, so getting a long term 4% is easy. In year 1, I get 2676 in interest, so I need to take 2748 from the principal. After 10 years of this, I still have 33,907. At 15 years, I have 11875 left, not much, but 11875 more than the annuity expects I should have left, as I'm supposed to be dead now.

So if I want to leave my heirs anything, an annuity isn't the way to do it.