Hurt by inflation, Americans yearn for pensions in retirement. One answer may be annuities

Inflation continues to ravage Americans' savings, making them nostalgic for a retirement benefit of yesteryear: the pension. 

Ninety percent of Americans saving in a company retirement plan, such as a 401(k), worry it doesn't provide a reliable stream of income that can withstand the financial strains posed by inflation, which hit a 40-year high in 2022, according to a survey of 1,003 plan participants last fall by Greenwald Research. Seventy-six percent, up six percentage points from a year ago, worry they’ll run out of money, and 83% percent now want guaranteed lifetime income, the poll by the independent researcher said. 

Until about the 1980s, the pension, or defined benefit plan, “was a very, very successful program for people,” said Phil Maffei, head of corporate retirement solutions at insurance company TIAA. “You would get a portion of your income delivered as income for life when you retired.” 

What happened to pensions? 

Pensions can be expensive and risky for companies. Companies fund pensions and decide how to invest and grow them to keep them fully funded. It’s also tricky to predict how much an employer will need to meet their retirees’ pension obligations, especially with people living longer. 

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Pensions also siphon away money that companies otherwise could use for investments that enhance the bottom line. 

Pensions are still common in the public sector, with 86% of government workers having access to them in 2022, compared to just 15% of private sector workers, according to the Bureau of Labor Statistics. 

For these reasons, companies moved toward defined contribution plans like 401(k)s, which shift the risk to employees. Employees became responsible for funding their retirement plans, with the company sometimes agreeing to match a small amount. They are also responsible for investing and growing their money and deciding how much, if any, to withdraw. 

What went wrong with the defined contribution plan, or 401(k)? 

The jump to 40-year high inflation exposed the fragility of 401(k)s. People struggling to afford everyday necessities dipped into their nest eggs or reduced their contributions. Aggressive interest rate hikes further strained household finances, and financial market turbulence deflated 401(k) balances, igniting a wave of retirement worries.  

Most of the record 4.1 million boomers turning 65 each year from 2024-2027 don't have pensions, according to Jason Fichtner, chief economist of the Bipartisan Policy Center. The next-oldest generation, called Generation X, may be even worse off. They saved much less and were "the first generation to rely on 401k plans instead of pensions and the next in line to retire,” said Deb Boyden, Head of U.S. Defined Contribution at Schroders, in a statement last December.

In January, online Medicare learning resource center MedicareFAQ surveyed 569 retirees, and 59% said they’re concerned about their finances in retirement. Recent research from Fidelity Investments shows that while young people have recovered their 401(k) losses from 2022’s market volatility, older adults haven’t. 

Also “the 401(k) plan was really designed to accumulate assets,” Maffei said. “It never was designed to provide income.” What we need to do now is figure out how to turn that money into a lifetime stream of income, he said. 

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Will pensions return? 

Maybe, but in different clothes. 

When the United Auto Workers (UAW) union walked out last summer at the big three automakers, one of its demands was a return to pensions. Ford Chief Financial Officer John Lawler called pensions a “plan of the past,” and offered instead beefed-up 401(k) company matches. 

What UAW finally received was an annuity option in their defined contribution plan. It essentially allows them to create their own personal pension by converting some of their 401(k) money into an annuity.  

What is an annuity? 

An annuity is a contract you buy from an insurance company that can guarantee you an income. Some allow regular payouts until you die or for a fixed number of years. 

How much you would receive varies, based on several factors, including age, how much you pay for the annuity, the insurance company, and the interest rates at the time the annuity was bought. Generally, annuities are popular when interest rates are rising or high because you can lock in a higher return. And they're usually offered when someone's near retirement, said Tina Wilson, chief product officer at retirement plan provider Empower.

Annuities have been around for a long time, but have drawn some complaints that they're expensive, complicated and tie up your money so you can't access it in case of an emergency. However, proponents say many of those issues have been worked out since Congress included a provision in the Secure Act, passed in December 2019, to allow annuities inside defined contribution plans.

For example, the UAW plan offers workers a discounted price for the annuity and is customized to make sure employees keep a portion of liquid savings.

"Nobody should annuitize their entire (401(k) balance," Maffei said.

People heading into retirement should figure out what their recurring living expenses are for things like food, medical, housing, insurance premiums and what's covered by Social Security and other forms of steady income. "Whatever’s left that’s not covered by that secure source of income, that’s probably at least the amount that you should convert from your 401(k) plan to a stream of lifetime income," he said.

You would continue to hold investments that can grow in your 401(k), but the annuity would provide some stable income.

“Employees are anxious to get income options available to them,” said Wilson. "It gives them peace of mind.” 

“There’s nothing incredibly mystical or mythical about annuities,” Maffei said. “They simply are a way to insure your income stream. We insure our autos, we insure our health, we insure our home. We get umbrellas policies. We do all sorts of insurance. And annuities are just insuring an income stream.” 

Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her at [email protected] and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday.