May 3, 2010 

Submitted Electronically 

Office of Regulations and Interpretations 

Employee Benefits Security Administration 

Room N-5665 

U.S. Department of Labor 

200 Constitution Avenue, NW. 

Washington, DC 20210 

RE: Request for Information Regarding Lifetime Income Options for Participants and 

Beneficiaries in Retirement plans 

Financial Engines welcomes the opportunity to respond to the Request for Information 

Regarding Lifetime Income Options for Participants and Beneficiaries in Retirement 

Plans of the Employee Benefits Security Administration's ("EBSA"), Department of 

Labor, and the Internal Revenue Service, Department of Treasury, published on 

February 2, 2010. Our comments are focused on three different aspects of the issue: 

• Defined Contribution plans and lifetime income (Question 8) 

• Lifetime income options (Question 2) 

• Default considerations (Question 11) 

Defined Contribution Plans and Lifetime Income 

Unlike Defined Benefit (DB) pension plans, the vast majority of Defined Contribution 

(DC) pension plans do not provide options to help participants produce lifetime income. 

An important first question is – Should DC plans provide lifetime income options? Our 

belief is that in order for the vast majority of Americans to improve their chance of a 

secure retirement, DC plans and DC plan sponsors should play a large and positive role 

in helping plan participants create lifetime income. 

Key advantages of offering lifetime income solutions within DC plans include: 
• Access – A majority of individuals have account balances that are too low to 

attract help in the retail environment.1

 However, by aggregating many lower 

balance individuals, DC plans can potentially change the economics to make 

solutions viable for much lower account balances. For example, a face to face 

session with an individual with $50,000 in investable assets may not be viable in 

a retail environment, but a seminar with 50 similarly-situated participants at a 

given plan sponsor may be economically feasible. 

• Fees – Plan sponsors will be able to negotiate on behalf of their plan participants 

to get improved pricing for lifetime income solutions. Just as plan sponsors often 

are able to offer lower expense ratio investment options, sponsors will also likely 

be able to negotiate institutional pricing for lifetime income solutions. Lower 

costs generally translate into improved income for plan participants. In addition, 

fee disclosure requirements should lead to better transparency and a clearer 

understanding of the various pricing elements of the solutions for participants. 

• Quality – Due diligence on a myriad of lifetime income solutions can be a 

daunting task for many individuals. Lifetime income solutions available inside a 

DC plan give plan participants the ability to benefit from the due diligence review 

performed by the DC plan sponsor. This due diligence, particularly when 

performed by a plan sponsor acting as a fiduciary, can be important as the 

potential complexity of lifetime income solutions offered to participants increases. 

Given the benefits to plan participants from DC plan based lifetime income solutions, we 

believe it is critical for the Department of Labor and Department of Treasury to take 

action to reduce barriers and encourage plan sponsors to offer lifetime income solutions. 

Lifetime Income Options 

The marketplace for lifetime income is rapidly innovating new solutions. Innovation is 

occurring in both the insurance industry (e.g., longevity insurance, guaranteed minimum 

withdrawal benefits, accumulation phase income credits, etc.) and in the asset 

management industry (e.g., fixed horizon payout funds, fixed percentage payout funds, 

inflation protected payout funds, etc.). While innovation is occurring, it is less clear 

which types of solutions will ultimately be favored by individuals. Given the current pace 

 

1

 Cerulli Associates, 2009 estimates that 55% of households age 55-70 and 61% of households age 70+ 

have less than $250,000 in investable assets (often viewed as a minimum asset level given customer 

acquisition and retention costs). 
of innovation and uncertainty associated with the ideal lifetime income solution, we 

believe it is important that policy decisions not impede the creation and ultimate 

deployment of new and innovative lifetime income solutions in DC plans. 

Immediate annuity options 

Economic theory suggests that immediate annuities are highly desirable and predict 

widespread immediate annuity purchases by individuals. In practice, however, only a 

tiny minority of individuals actual purchase an immediate annuity. Acknowledging this 

reality, Question #2 asks: 

Currently the vast majority of individuals who have the option of receiving 

a lump sum distribution or ad-hoc periodic payments from their retirement 

plan or IRA choose to do so and do not select a lifetime income option. 

What explains the low usage rate of lifetime income arrangements? Is it 

the result of a market failure or other factors (e.g., cost, complexity of 

products, adverse selection, poor decision-making by consumers, desire 

for flexibility to respond to unexpected financial needs, counterparty risk 

of seller insolvency, etc.)? Are there steps that the Agencies could or 

should take to overcome at least some of the concerns that keep plan 

participants from requesting or electing lifetime income? 

Likely all of the identified factors play a role in making lifetime income less desirable. 

However, one aspect of this issue receives little attention, but deserves highlighting. 

Often the choice of purchasing lifetime income (or “annuitizing”), is evaluated as a binary 

yes/no decision. Considering the decision to annuitize as a now or never decision 

suggests dramatic benefits to annuitizing now. However, an individual always has the 

option of annuitizing some assets at a later point in time. In reality, the decision is best 

characterized as a now or later decision rather than a now or never decision. 

Viewed in this context, the benefits of purchasing an immediate annuity at retirement are 

much less compelling. Annuity fees imply that, even with a goal of maximizing 

retirement income, an individual might still rationally defer the annuity purchase to a 

point when they are older. The essential comparison is between the extra “mortality 

return” earned by annuitizing early versus the marginal fees avoided by delaying the 

annuity purchase.2

 Since annuity fees can often be large compared to the mortality 

return for younger retirees, women and especially couples, deferring the annuity 

purchase until a more advanced age is often desirable. For younger retirees, the 

 

2

 See Milevsky and Young, 2005 or Scott et al., 2009 for a discussion of the impact of fees on the decision 

to defer the annuity purchase. 
mortality return from annuitizing is low because they are very likely to be alive in the next 

few years. It may be cheaper to fund these years of retirement with lower cost fixed 

income instruments, rather than pay the higher fees associated with annuities. 

Further, there are more considerations than simply maximizing lifetime income. Earning 

the “mortality return” involves giving up the flexibility associated with a liquid pool of 

assets. Given all of the changes that occur at retirement, it is no surprise that many 

individuals place a high value on the flexibility available from a liquid pool of assets. 

Finally, for many individuals, an immediate annuity is an unfamiliar product that differs 

significantly from the investments they have become accustomed to during their years of 

accumulating wealth. Given this type of choice, it is not too surprising that retirees 

overwhelming choose a lump-sum over lifetime income at retirement. 

While we believe immediate annuities are important lifetime income options, we do not 

believe policy decisions are likely to change the fundamental preference retiring 

individuals have for the flexibility and liquidity associated with a pool of assets. As such, 

we believe it is crucial that new policies allow for innovative lifetime income solutions that 

more closely align with individual preferences. 

Hybrid lifetime income options 

Hybrid solutions combine investments and insurance to create lifetime income. A hybrid 

solution can overcome some of the problems identified with immediate annuities. The 

previous discussion argued that, at retirement, an immediate annuity offers a dubious 

combination of inflexibility, unfamiliarity and low or negative economic urgency. 

However, the situation changes at more advanced ages. As an individual ages, the 

economics of an annuity become increasingly compelling (i.e., the mortality return 

substantially exceeds plausible insurance fees). A hybrid solution combining 

investments and flexibility in early retirement followed by insurance and security in late 

retirement could be much more desirable to individuals. The hybrid option could be 

delivered in a number of different ways including a variable annuity insurance product or 

as a managed account. In a managed account option, the management would create 

income in the early retirement years while always maintaining sufficient assets to give 

participants the option of increasing the income payout through an annuity purchase. 

The advantage of the hybrid approach is that as the insurance becomes compelling, the 

hybrid solution facilitates a shift from a highly liquid and flexible solution to one more 

focused on guaranteed lifetime income. 
Given the alignment between hybrid solutions and participant preferences, we believe it 

is important that future policy decisions support the development and deployment of 

hybrid lifetime income options for DC plan participants. 

Advisor-assisted options 

While hybrid solutions allow for a tradeoff between flexibility and income, they still face 

the problem that the annuity remains an unfamiliar choice. Without some sort of 

assistance, it is unlikely that many individuals will independently decide to annuitize late 

in retirement. There are a number of ways to address this issue. First, a plan sponsor 

could create education materials to help their participants better understand the everimproving potential for insurance to provide lifetime income. Unfortunately, educating 

DC plan participants has met with mixed to poor results historically. An alternative 

approach is to offer an advisor-assisted lifetime income option. An advisor could 

augment many lifetime income options. For discussion purposes, consider access to an 

advisor as a component of the hybrid lifetime income solution. The purpose of the 

advisor would be to explain the flexibility versus security trade-off associated with 

annuitization. While advisors are uncommon in the retail environment for individuals 

with modest balances, the economies of scale associated with a DC plan may be one of 

the few areas where independent advisor assistance is economically feasible. 

Similar to hybrid solutions, advisor-assisted options may ultimately prove to be the 

option most preferred by DC plan participants. Therefore, we believe it is important that 

future policy decisions support the development and deployment of advisor-assisted 

lifetime income options for DC plan participants. 

Longevity insurance options 

The interaction between required minimum distribution (RMD) rules and longevity 

insurance offers a good example of the potential for unintended consequences 

associated with policy decisions. Current RMD rules discourage the use of longevity 

insurance as a lifetime income solution. As discussed below in the longevity insurance 

overview, the efficiency of longevity insurance relies on the gap between the purchase 

date of the insurance and the date income begins. By delaying the beginning of the 

income phase, an individual can purchase income at a substantial discount. A typical 

policy might have a purchase date at age 65 with income beginning at age 80. Mortality 

between 65 and 80 creates a substantial discount on late-life income. 
However, this type of insurance policy is disadvantaged given current RMD rules. If 

purchased with qualified dollars, the value of this policy counts in the RMD calculation, 

but the policy itself does not generate any income until age 80. What happens if there 

are insufficient funds outside of the insurance policy to pay for the required minimum 

distribution implied by the value of the policy? That concern has kept longevity 

insurance providers from accepting qualified dollars for policies with payouts that begin 

after age 70. 

To remedy this situation, we strongly recommend that longevity insurance policies be 

exempted from the RMD calculation. Current RMD rules exempt immediate annuity 

purchases from the RMD calculation. Extending that exemption to cover longevity 

insurance is justified on the grounds that under many circumstances a portfolio 

combining liquid assets and longevity insurance can create a more desirable lifetime 

income solution (higher income and/or increased flexibility). In fact, given the policy 

benefits of sharing mortality risk, consideration should be given to exempting any 

insurance contract that focuses solely on life-contingent payments. Current RMD rules 

unnecessarily hinder the development of lifetime income solutions based on longevity 

insurance and should be updated accordingly. 

Current RMD rules have an unintended consequence of placing longevity insurance at a 

disadvantage in the market place. We believe future regulatory guidance should ensure 

that longevity insurance-based solutions and other innovative approaches remain viable 

alternatives. 

Longevity Insurance Overview 

Longevity insurance (sometimes referred to as a deferred annuity or a longevity annuity) 

allows an individual to purchase life-contingent income that begins at a future date. For 

example, a longevity insurance policy purchased at age 65 may have income payments 

that do not begin until age 80. The payouts from the policy are inexpensive because 

they are contingent upon living to an advanced age to collect. Recent research has 

demonstrated that longevity insurance arrangements maximize the income benefit per 

insurance premium dollar spent. For example, Scott, 2008 estimates that “for a typical 

retiree, allocating 10%-15% of wealth to a longevity annuity creates spending benefits 

comparable to an immediate annuity allocation of 60% or more.” Moreover, since 

insurance costs tend to be proportional to the premium payment, longevity insurance 

can help minimize insurance costs (see, for example, Scott et al., 2009). 
Longevity insurance research implies that individuals looking to allocate only a portion of 

their assets to insurance can typically improve their income level by utilizing longevity 

insurance instead of traditional immediate annuities. Since few individuals want to fully 

annuitize their assets, longevity insurance could play an important role in the creation of 

desirable and palatable lifetime income solutions. 

Defaults Considerations 

The automatic 401(k) is proving to be very effective in creating participant success by 

default. Since the decisions required by participants for successfully drawing down 

income during retirement are far more complex, extending the automatic 401(k) in the 

retirement phase will be critical. However, the circumstances faced by retiring plan 

participants can vary widely. As such, different plan sponsors may feel different defaults 

are most appropriate for their plan population. Thus, similar to the accumulation phase, 

a menu of “qualified” defaults is likely necessary to give plan sponsors needed flexibility. 

Given the substantial impact a default can have on participant outcomes, many plan 

sponsors will require an explicit “safe harbor” in order to adopt a lifetime income default. 

As such, determining which lifetime income solutions qualify as approved defaults will be 

a critical policy decision. To help identify candidate default solutions, we believe the 

following characteristics are important: 

• Fee reversibility – In the accumulation phase, qualified default arrangements 

must be fully reversible at no cost for 90 days. A similar guideline should apply 

to retirement defaults. 

• Liquidity – Some insurance products, such as an immediate annuity, exchange 

liquidity for additional retirement income. However, a default that involves the 

loss of liquidity could be a significant shock to unaware participants. To manage 

this concern, we recommend either an extended period where liquidity is retained 

or a requirement that loss of liquidity requires a proactive participant decision. 

• Death benefit – Insurance that maximizes income will not pay a death benefit. 

However, in a default context, the lack of a death benefit could also be surprising 

to the heirs of DC plan participants. Similar to liquidity provisions, we 
recommend either an extended period where a death benefit is retained or a 

requirement that loss of a death benefit requires a proactive participant decision. 

• Conflicts – If the retirement default is an advisory relationship that helps 

participants with drawdown decisions, existing rules governing prohibited 

transactions should extend to lifetime income services. Participants should be 

protected from advice that could be influenced by conflicts of interest associated 

with the compensation of the advisor. 

• Role of Fiduciary in Selecting Default– If a retirement income solution is made 

a plan default, we recommend that the plan sponsor still play a fiduciary role in 

the selection and monitoring of any such default. 

Thank you for considering these comments. Please do not hesitate to contact me if you 

have any questions or if I can be of any assistance. 

Jason Scott, PhD 

Managing Director, Retiree Research Center 

Financial Engines, Inc. 

References 

Cerulli Associates. 2009. The Cerulli Report – State of Retirement Income: Addressable 

Opportunity, Strategies, and Future Outlook. 

Milevsky, M. A. and Young, V. R. 2005. The Timing of Annuitization, Investment 

Dominance and Mortality Risk Insurance: Mathematics and Economics, 40(1): 35-144. 

Scott, J.S. 2008. The Longevity Annuity: An Annuity for Everyone? Financial Analysts 

Journal. 64(1): 40-48. 

Scott, J.S., Watson, J.G. and Hu, Wei-Yin, 2009. What Makes a Better Annuity? Pension 

Research Council Working Paper 2009-03. (forthcoming – Journal of Risk and 

Investment)