DIAs as a 401(k) Default

Very few defined contribution (DC) retirement plans in the U.S. today pay out lifetime income streams—a scarcity that leaves many retirees at the risk of running out of money.

Researchers from the Brookings Institute have suggested a partial solution to this problem. They recommend that an employer include deferred lifetime income annuities (DIAs) as a default in its company-provided 401(k) plan. They conclude that defaulting a portion of employees’ portfolios into a DIA “is a practical and attractive way for plan sponsors to provide a lifetime income for workers in defined contribution accounts.”

To annuitize 10% of a participant’s assets should reduce his concern about lacking liquidity in old age. The researchers suggest persuading DC plan sponsors to describe all benefit amounts in their 401(k) plan as monthly or annual income streams. This will emphasize the role of the DIA in helping retirees meet consumption needs, rather than as a “loss” of access to a portion of their account balance.

“It is also likely that retirees whose consumption needs are covered by a relatively secure income stream from Social Security paired with their DIA benefits would be willing to take more investment risk with their liquid 401(k) or IRA [individual retirement account] assets,” the report says. “In this way, the DIA could help enhance retirement security, enabling households to benefit from the equity premium later in life. This could be a particularly important strategy in light of the permanently lower interest rates that many financial economists expect in the future.”