GAO: Current Retirement Income Options Have Drawbacks

In a letter to Senator Herb Kohl, chairman of the Committee on Aging, the GAO said retirees have three primary options to generate a lifetime income stream: participants in defined benefit (DB) plans can receive their benefits as a lifetime annuity; retirees with defined contribution (DC) plan assets can purchase individual life annuities provided by insurance companies that offer retirement income on a lifetime basis; and individuals can defer retirement under Social Security by a few years (up to age 70) in order to receive higher monthly benefits. However, the GAO noted there are drawbacks to each of these options. 

Although private-sector DB plans are required by law to offer a benefit in the form of an annuity, a growing number of these plans are also offering lump-sum options at retirement. According to investment company officials the GAO spoke with, many workers retiring with a DB plan choose a lump sum over an annuity. In addition, nearly one-third of participants in single-employer DB plans are enrolled in hybrid plans, such as cash balance plans, which often express benefits as account balances rather than monthly annuity benefits, and offer lump-sum payouts as well as annuity payments. 

The GAO also pointed out that few households—about 6%—owned individual annuities in 2007. Only 3% ($8 billion) of the total amount of annuities sold in 2008 were fixed immediate annuities, designed solely to provide lifetime income. The letter cited findings from the Insured Retirement Institute (IRI) that indicated the majority of annuities sold are deferred annuities, which are rarely converted to lifetime income. In 2008, less than 1% of deferred annuities sold were converted to lifetime income.  

The GAO also noted many retirees lack sufficient financial assets to buy an annuity that would replace more than a small fraction of their preretirement income, and according to insurance industry representatives, few annuities provide monthly lifetime income with payments adjusted for inflation. Also, annuities generally leave nothing for heirs; payments end at the death of the annuitant (and his or her spouse, in the case of joint and survivor annuities).

While some disadvantages of annuities can be addressed by options available from insurers, such as protection against inflation, these options often reduce monthly income or increase the total cost to purchasers, according to the GAO.  

Finally, the letter noted that delaying Social Security benefits is not an option for many who cannot work and lack sufficient assets to live in retirement without the benefits. Workers who have shorter life expectancies, such as some minorities and less educated workers, are less likely to be better off by delaying the start of benefits, as they may not live long enough for the total amount of the higher delayed benefits to exceed the total amount of the lower benefits they would receive if benefits begin at age 62. 

The decision of when to begin receiving Social Security benefits is further complicated for married couples, according to the GAO. When the first spouse dies, the remaining spouse who is at full retirement age or older receives a benefit which is the greater of the remaining spouse’s earned benefit or a survivor benefit based on the deceased spouse’s record. If the higher earning spouse begins receiving Social Security benefits early, the surviving spouse may receive a lower survivor benefit.