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Tackling the issue of lifetime income

Some of the best minds in finance have turned their attention to the problem of providing retirees with vehicles that ensure they will not outlive their retirement assets.

There are, of course, such vehicles offered by insurance companies — annuities, but they have been a tough sell to workers approaching retirement. Nobel laureate Richard Thaler suggested combining an employee's retirement savings with Social Security to make the idea of an annuity more acceptable. That is, an employee would buy an annuity from the Social Security Administration.

Another Nobel laureate, Robert C. Merton, and Arun Muralidhar, a co-founder of Mcube Investment Technologies LLC, proposed instead that the federal government issue a special bond that would pay an inflation-adjusted coupon of $5 per year at retirement age for a period equal to the average life expectancy of the economy, currently 20 years. The new bonds, to be called SeLFIES (Standard-of-Living indexed, Forward-starting, Income-only Securities) would protect against both inflation and the risk of standard-of-living improvements.

Workers would fund their desired retirement income by buying a target number of SeLFIES that would be determined by dividing the desired income by $5. The government-guaranteed bonds should be easier to explain than annuities. The prices of the bonds would be set by the market.

Both ideas have positive aspects, but both have weaknesses.

Mr. Thaler's idea has appeal in that most employees understand they will get a regular check from the Social Security Administration when they retire (though they are skeptical they will get the full amount) and that they have purchased this during their entire working lives. In effect, they have bought an annuity, though they don't think of it that way.

But the idea fails to deal with the fact that workers seem not to like to buy annuities. This may be because they appear costly and illiquid, and the buyer might be afraid of dying before enjoying the full stream of payments they have paid for. In addition, their heirs may not receive anything from the annuity.

In addition, as Messrs. Merton and Muralidhar noted in their proposal, the Social Security system is not set up to offer annuities on an individual basis, and workers likely would be reluctant to buy annuities from Social Security, which they are constantly hearing will run out of money before 2035.

The Merton-Muralidhar idea has more charm because most workers are at least somewhat familiar with government bonds, if only through savings bonds bought for them as children, or bought by them for children, so they should be an easier sell.

They also note that plan sponsors should like SeLFIES because they would be a true "safe harbor" being backed by the full faith and credit of the U.S. government. They could also be used in target-date funds, and insurance companies could find them useful for hedging annuity obligations.

But SeLFIES also have weaknesses, as the two academics acknowledge. A key one is that they do not fully address every retiree's longevity risk. What happens if the retirees outlive the bonds? That possibility would have to be addressed by the workers in some other way, adding a complication to what was supposed to be a simpler way to ensure they did not outlive their retirement savings.

Another weakness, which it shares with the Thaler proposal, is Congress, which has been a graveyard of creative pension improvement ideas. Either of these ideas would have to be marketed first to Congress and later to employees so they could understand and embrace them.

Now is the time to begin exploring solutions to the longevity risk. The two current proposals might not be perfect, but there might be ways to improve them. For example, perhaps Mr. Thaler can use behavioral finance insights to change worker attitudes regarding annuities. Or perhaps, Messrs. Merton and Muralidhar can find a way for SeLFIES to cover retired lives beyond the average of 20 years.

Maybe the efforts of these top academics will inspire other, better, ideas.