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Published: June 2010

Regulatory role of Labor Department should frame debate on retirement plans

Fund Democracy, Consumer Federation of America,and Consumer Action wrote a letter responding to a call for information on the Department of Labor's proposed changes to 401(k) retirement plans.

Below is a summary of the letter:

We are writing on behalf of Fund Democracy, Consumer Federation of America and Consumer Action in response to the Department’s request for information on Lifetime Income Options for Participants and Beneficiaries in Retirement Plans (collectively, “401(k) plans”).  We support the Department of Labor’s efforts to improve Americans’ retirement security and its recognition of the changing structure of our retirement system.  Lifetime income options should be a core component of Americans’ 401(k) plans.

We believe that the consideration of lifetime income options, which we will refer to as “annuities,” is the kind of foundational inquiry that requires the Department to revisit the key principles that define its role in regulating 401(k) plans.  The answers to virtually all of the Department’s questions regarding annuities depend on fundamental assumptions about the Department’s regulatory role.  Our letter presents our views regarding what these fundamental assumptions are and, to a limited extent, provides initial answers to some of the Department’s questions on the basis of these fundamental assumptions.  

We cannot emphasize strongly enough the importance of the Department’s developing a coherent conception of its role before developing policies and making detailed proposals regarding annuities in 401(k) plans.  Regardless of whether the Department’s conception of its regulatory role conforms to our understanding, it is imperative that whatever policies it implements reflect a coherent, sustainable approach.  We believe that America’s current and future retirees are at risk1 and that this risk results as much from the government’s ambivalence in developing and implementing coherent policies as from the current structure of our retirement system itself.  

Initial Recommendations

Based on the foregoing discussion, we have the following initial recommendations regarding the role of annuities in 401(k) plans:

•  Mandatory Annuities.  We recommend that employers be required to offer two types of standardized annuities as 401(k) plan options.  The Simple Annuity would provide retirees with an immediate contractual right to a fixed, inflation-adjusted income stream for the life of the retiree or the retiree and their spouse.  It would have no investment or other features. Its only fee would be included in the lump sum purchase price. The Future Simple Annuity would be identical except that it could be purchased on an installment basis during a worker’s career and would provide an immediate contractual right to a fixed, inflation-adjusted, lifetime income stream beginning at the age of retirement.  The essential information about each Simple Annuity and Future Simple Annuity would be presented in a price/payout chart for different ages that would allow for easy comparison, and promote competition, among annuity providers. Employers should be permitted to offer other types of annuities, provided that the standardized Annuities received greater prominence and subject to new requirements applicable to variable annuities discussed below.

• “Guaranteed” Annuities.  The Department should consider requiring employers and/or annuity sellers to obtain reinsurance of annuities in excess of amounts recoverable from applicable state guaranty funds. 

Fixed annuities are routinely (and, we believe, falsely) advertised as providing a “guaranteed” source of income, although the seller’s promise is only as certain as its own creditworthiness and the amount of the coverage limit of the applicable state guaranty fund.  The greatest benefit offered by an annuity is the income security that it is held out as providing.  Employers and/or sellers should be required to reinsure annuities up to a minimum income level.  The maximum coverage for defined benefit obligations provided by the Pension Benefit Guaranty Corporation might be an appropriate benchmark ($4,500/mo in 2010), and the Department should consider recommending to Congress that the PBGC itself provide reinsurance at least for the mandatory Simple Annuities discussed above.

• Variable Annuities.  The Department should not “encourage” the use of variable annuities.  To the contrary, the Department should take steps that recognize the long-term, pernicious effect of variable annuity sales abuses on America’s investors.  We recommend that the Department consider special requirements to protect plan participants against these abuses.  For example, the Department could require employers to obtain from sponsors of variable annuities that are offered as 401(k) plan investment options a plain English analysis of the sponsor’s determination that the benefits of each non-investment feature of the variable annuity exceeds its cost and cannot be obtained at lower cost by other means.  For example, the sponsor of a variable annuity that offers the option to convert to an income stream at a future date would be required to show that the additional benefit provided by that option exceeded its cost (with data on the actual frequency with which annuity options are selected being incorporated into this analysis).  If a variable annuity offered a death benefit that guarantee a minimum account value upon the death of the owner, the sponsor should have to demonstrate that the relevant risk of loss could not have been achieved more efficiently by other means, such as through the purchase of a term life policy and/or a reduction in the risk of the assets underlying the variable annuity.

We strongly support the Department’s evaluation of the role of annuities in 401(k) plans and sincerely hope that it will not refrain from the full exercise of its responsibilities in this area.  The retirement security of Americans has entered a precarious period in which systematic planning errors may have disastrous individual and societal consequences.  The Department has an obligation to act decisively to guide the investment decisions of the least sophisticated, most vulnerable 401(k) plan participants.

We look forward to working with the Department to strengthen Americans’ retirement security by developing a coherent plan for the full integration of annuities into the 401(k) plan marketplace.

Lead Organization

Consumer Federation of America

Other Organizations

Fund Democracy | Consumer Federation of America

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