February 2, 2012 / 6:17 PM / 7 years ago

Stern Advice: New 401(k) policies are a mixed bag

WASHINGTON (Reuters) - The Obama Administration took aim at the nation’s retirement worries on Thursday with a series of rules and proposals addressing everything from 401(k) fees to mandatory distributions and annuities for older retirees.

A man looks at poly-bags on display outside a factory at Ludhiana in the northern Indian state of Punjab January 18, 2012. REUTERS/Ajay Verma

The package, taken as a whole, will likely provide some help for workers, but insurance companes will probably be the most excited about it immediately.

That’s because the Treasury Department took several steps to encourage employers and their workers to include annuity products in retirement plans.

“We’re very happy,” Cathy Weatherford, president of the Insured Retirement Institute, an annuity trade group, told me. “We have been so pleased by the Treasury and Labor ... (Departments) work on this issue.”

Will workers and retirees be pleased, too? Much depends on how the rules are put into effect and how employers, financial companies and workers react. Here’s a first take on the way your 401(k) may change and what you should do about it now.

- Fees first. For younger workers and anyone who still thinks they’ll be using a 401(k) plan for the next decade, the fees you pay for everything from record keeping to investment management really matter. For example, the Labor Department has calculated that an extra 1 percentage point of interest on just $25,000 after 35 years would be $64,000, a difference that could reduce a retiree’s income stream by $213 a month for life.

The new Labor Department rules mean that companies will have to disclose all of the costs of their 401(k) plans to workers after August 30. For workers, that’s a no brainer: Read the disclosures, even if they are hard to find and understand. If you’re choosing expensive funds within your plan, ask yourself why. If your company’s plan is so expensive as to be noncompetitive, ask your employer why. He or she has a fiduciary responsiblity to offer a plan that is in the best interest of the participants.

- Annuities later. The Treasury Department unveiled a series of proposals and final rules designed to help workers annuitize some of their retirement savings. The theory is this: a retiree facing an unknown lifespan can use an annuity to guarantee at least some income for life.

The proposals are especially encouraging of longevity annuities that are deferred. Typically, a worker or new retiree would buy a longevity annuity with a fixed sum of money in his 50s or 60s. The policy wouldn’t make any payments until the consumer turned 80 or 85 and then it would make guaranteed payments for life. They offer protection against that widely feared risk of outliving your money.

The Treasury is proposing that workers who use tax-deferred money (such as in a 401(k) or rollover individual retirement account) be allowed to exempt the purchase price of the annuity from the amount of money they would have to start withdrawing at age 70 1/2 under mandatory distribution rules. It also eases spousal consent and traditional pension rules that might make it more difficult for employers to offer deferred annuities to their workers.

- There are different kinds of annuities. There’s been a lot of publicity about how horrible it was when workers were persuaded to put tax-deferred annuities into retirement plans, but that referred to variable annuities, a different kind of product. Those were designed for people who wanted extra tax deferral beyond their 401(k)s and IRAs. They are long-term investment vehicles that offer some tax deferral, but not fixed lifetime payouts. When tucked into a 401(k) or similar plan, they tended to pile up fees without offering added advantages.

The new focus is on fixed immediate and deferred annuities, which do provide lifetime income at a fixed cost. They have their risks because they depend on the insurance company being there to make payments 20 and 30 and 40 years down the road, and because the purchaser actually loses control of the money they’ve used to purchase the annuity. But they’re a different animal.

- Partial is good. The Treasury’s proposals and rules focus on the concept that retirees may want to annuitize some of their money, but not all of it. That’s a concept that is widely embraced, even by companies that make money selling annuities. If these rules become effective, workers with traditional pensions may be able to take part of a lump sum and part of an annuity, something that’s rare and difficult now. People retiring with 401(k) plans would also be able to put a piece of that money to work in an annuity or their company’s pension plan without committing the whole thing.

Near retirees shopping for annuities should think about their whole picture before committing that money, says David Hultstrom, a Woodstock, Georgia, financial adviser. If they already hold a lot of bonds and expect a pension or solid Social Security benefits, that would reduce the amount they might want to annuitize.

There’s no need to race. Most workers won’t see their companies offering annuities anytime soon, concedes David Wray of the Plan Sponsor Council of America, an employer group. He said employers would be concerned about choosing solid insurance companies and reasonably priced annuities for their workers.

“The purchase of this insurance will be in IRAs, not plans,” he said. “Plan sponsors will continue to have the same concerns about the fiduciary liability of recommending providers to their employees” that they have without these regulations, he said.

Furthermore, this is a particularly expensive time to buy deferred annuities, because payouts are calculated on the basis of market interest rates that keep grazing historic lows, said Hultstrom.

“With today’s rates, nobody’s going to get a good deal now on an annuity anyway,” he added.

That means workers and retirees have time to see how the rules shake out and to do some careful planning on how much and what kind of annuity to buy before racing to this market.

(The Personal Finance column appears weekly, and at additional times as warranted. Linda Stern can be reached at linda.stern@thomsonreuters.com; Linda Stern tweets at www.twitter.com/lindastern.;

Read more of her work at blogs.reuters.com/linda-stern;

editing by Andre Grenon)

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