Wednesday, August 13, 2014

Can Retirees Successfully Survive in a World of 401(k) Plans?

In his latest paper, Rethinking ERISA's Promise of Income Security in a World of 401(k) Plans, Professor Lawrence Frolik of the University of Pittsburgh School of Law, paints a reasonably depressing picture of retirement in the future.  Professor Frolik correctly points out that as employers and other plan sponsors transition out of defined benefit plans and into defined contribution plans, "retirees face formidable planning hurdles."  Not only must they be responsible for investing their retirement assets in this world, but they "must spend their retirement fund at a rate that will not exhaust it before they die, yet take a sufficient amount out, that when added to their other sources of income...will enable them to live at the level that they deem adequate." 

Professor Frolik presents an impressive argument that because of diminished physical and mental capacity, many retirees will not be up to the task.  He concludes that the use of annuities must be encouraged by our government.  He says, "unless the government does something to encourage the use of annuities by IRA owners, the financial security of many retirees will be severely compromised in the years to come.  We can expect rates of elderly poverty and increasing financial exploitation and abuse."

He pulls no punches by concluding, "The assumption that retirees can successfully manage their IRAs during their declining years is a folly.  Why any society would willfully create a retirement system that relies on the financial acumen of millions of aging individuals can only be explained as the triumph of hope over common sense and reality."

Whether you agree or not with Professor's assessment of the implications of living in the "World of 401(k)s", he does make a good argument for diversification of risks in retirement through purchase of life annuities (immediate and/or deferred) with some or all accumulated retirement assets, and he makes a good indirect argument for using a relatively simple approach like the one proposed in this website, for determining a spending budget in retirement. Under any circumstance, however, there should be a plan in place for transfer of financial responsibilities to a competent party when an individual becomes physically or mentally incompetent.