Using Defaults to Enhance Adoption of Lifetime Income in Defined Contribution Plans

Most 401(k) participants accumulate wealth for retirement in qualified default investment alternatives (QDIAs) such as target date funds that are designed to provide a life cycle appropriate mix of stocks and bonds for accumulation. Shifting a portion of savings to an annuity would allow retirees to spend more each year by delegating longevity risk to an insurer. The 2019 SECURE Act increases protections to plan sponsors who incorporate annuities into a QDIA, but adoption has been surprisingly slow resulting in low rates of lifetime income protection among employees. We review barriers to adoption with the defined contribution (DC) system including liquidity requirements, product design, and the need for active election of an annuity. We suggest three solutions to reduce these barriers. Defaults that include an annuity option are currently designed to require an active choice to receive lifetime income at retirement by participants. Evidence from other countries and participant surveys suggest that a high percentage would select some allocation to an annuity. Second, product innovation that allows participants access to liquidity with an automatic lifetime income benefit may be easier to implement than full annuitization. Care should be taken to design a product that is unlikely to be misused by less knowledgeable participants. Third, a regulatory entity that oversees commutation among insurers offering annuities within DC plans can reduce risks related to liquidity and the transfer of income liabilities to lower-rated insurance companies.