Proposal asks 401(k) plans to provide retirement-income projections

BOSTON - It might increase the amount of money people set aside to pay for their expenses in retirement. Then again, it might have some unintended consequences as well. Workers saving for retirement just might take on more risk than necessary in hopes of making up for not saving enough. What is it?

U.S. Sens. Jeff Bingaman, D-N.M., Johnny Isakson, R-Ga., and Herb Kohl, D-Wis., last week introduced a bipartisan bill that would require employers who sponsor 401(k) plans and the like to inform plan participants of the projected monthly income they could expect at retirement based on their current account balance.

So, for instance, employers would tell workers in their 60s who might have $170,000 in their 401(k) that their nest egg would produce $10,000 per year in today's dollars were it to be invested in a joint-and-survivor annuity, or $7,000 per year on an inflation-adjusted basis.

Retirement-planning experts say that sort of income information could be a good thing in some ways. For instance, the Social Security Administration each year mails working Americans a statement informing them of estimated monthly benefits based on their current earnings. At the moment there is no near equivalent for 401(k) plan participants: Many don't have a clue how much income their plan might produce.

Not surprisingly, the AARP, the Women's Institute for a Secure Retirement and the Retirement Security Project, among others, are backing the legislation.

But knowing how much or how little one's 401(k) might produce could be a bad thing as well, according to Michael Zwecher, author of "Retirement Portfolios: Theory, Construction and Management."

Consider the case of the average 401(k) participant whose account balance, according to the Investment Company Institute/Employee Benefit Research Institute, at year-end 2008 was $45,519, down from $65,454 at year-end 2007. That worker, under the provisions of the bill, would learn that nest egg would produce in today's dollars an estimated paltry $2,700 per year or $225 per month of income in retirement.

And once a worker learns how little their 401(k) might produce, Zwecher says one of two things happen. Best case, they increase the amount they contribute to their 401(k), which presently averages 7 percent. Or, worst case, they increase the amount they invest in stocks, thus increasing their exposure to market risk. At the moment, the evidence seems to suggest that many workers don't have a clue about how to invest the money in their 401(k)s.

For instance, they still have too much invested in their company's stock. Yes, the percent invested in company stock is down a full percentage point from 2007 to 2008 according to the EBRI/ICI 401(k) database. But even at 9.7 percent, it's still high.

"Workers, by the nature of the stream of their employment income, already have a concentrated position in the firm employing them," said Zwecher. "Adding to the high concentration by investing 401(k) funds or through an employee stock purchase plan into greater exposure is dangerous."

Rick Miller of Sensible Financial Planning agreed. "Nearly 10 percent of assets in this category is a distressingly large figure, especially since only half of all participants have access to company stock," he said.

And then there's the issue of how many 401(k) investors are unclear on the concept of target-date funds. Workers who invest in target-date funds inside their 401(k) don't really need to invest in other funds inside their 401(k). But they do. Among plan participants in their 60s, almost 6 percent of their 401(k) assets were invested in target-date funds, according to a recent EBRI report. "Some investors in target-date funds... apparently do not understand the purpose of the funds and could end up with a potentially inferior portfolio in terms of risk/return tradeoff," EBRI said.

By the way, this notion of using annuities as an income option for 401(k) plan participants is gaining traction. Labor Department Secretary Hilda L. Solis last week said the government plans to investigate how it can encourage the use of lifetime annuities or similar investment products. "We're looking at whether people might not be able to get their money in a monthly check (in a stream) that will last their lifetime so they won't have to worry about it," she said in a Web chat Monday.

Now don't get us wrong here. The idea of telling workers how much income their nest egg will produce or the use of lifetime annuities does have merit. But the proposed law and the Labor Department should address, among other items, financial literacy and investor education.

For instance, Zwecher said telling an investor the amount of income a 401(k) might produce by investing in an annuity ignores the risk that comes with such products. A person who buys an annuity does indeed eliminate one of retirement's biggest risks-longevity. You won't outlive your assets with an annuity.

But annuities do come with credit risk, the risk that the insurer selling the annuity could go belly up. What's more annuities don't offer protection against the risk of inflation, as do Social Security benefits or Treasury Inflation Protected Securities. By moving the money in your 401(k) from stocks and bonds to an annuity, Zwecher said, "you're simply trading market risk for credit risk."

According to Zwecher, 401(k) participants should be informed about all the risks and rewards of the major retirement-income options, not just the rewards from one product. The annuity option is just one piece of the puzzle. And presenting that option to the exclusion of others or presenting that option without presenting its risk could hurt just as much as it helps 401(k) participants.

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