Buying Annuities in Your 401(k)

Despite the economic challenges presented by the COVID-19 pandemic, the vast majority of workers continued to contribute to their retirement plans in 2021, according to the Investment Company Institute. All told, Americans have more than $11 trillion stashed in plans offered through their jobs.

But even though workers get a lot of advice and encouragement on their journey to retirement, they are often left on the tarmac when they reach their destination. Historically, employers have provided little guidance on what retirees should do with the big pile of money they’ve accumulated over the past 40 or 50 years.

Now, a growing number of companies are providing workers with a way to turn a slice of their savings into a monthly paycheck in retirement. In addition to the usual choices of mutual funds and other investments, they’re offering workers the option of investing in an annuity that can be converted into guaranteed income after they retire.

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Retirees can already purchase annuities from a variety of insurance companies, of course, but few do, even though many retirement experts believe that annuitizing a portion of your savings reduces the risk that you’ll run out of money in retirement. In large part, that’s because the security that annuities provide comes with some caveats: In exchange for guaranteed payments, you must hand over a large lump sum to an insurance company, and you usually can’t get that money back. In addition, some types of annuities are loaded with fees and restrictions that are often hard to decipher without professional help.

In the past, companies resisted offering annuities in their retirement plans because they feared they would be sued if the insurer went out of business. The 2019 Setting Every Community Up for Retirement Enhancement (SECURE) Act sought to address those concerns by providing employers that offer in-plan annuities a safe harbor from such lawsuits. To avoid liability, employers must still vet annuity providers to ensure that they’ve complied with state laws and have maintained healthy financial reserves.

Annuity Offerings on the Menu

Several companies that have added annuities to their lineups are offering them in their target-date funds. Target-date funds, which are owned by more than half of participants in 401(k) plans, provide a set-it-and-forget-it portfolio that gradually shifts to more-conservative assets as you near retirement.

For example, TIAA-CREF’s Secure Income Account, a deferred fixed annuity, replaces a portion of the fixed-income holdings in a target-date fund and accounts for 40% to 60% of the individual’s assets by the time the 401(k) owner retires, says Philip Maffei, managing director for corporate income products for TIAA-CREF. Upon retiring, the participant would have a choice of annuitizing all of the money in the account, annuitizing just a portion of it or taking a lump sum, Maffei says.

Fidelity Investments, one of the nation’s largest 401(k) plan managers, is providing its 401(k) clients with a menu of immediate annuities from up to five different insurance companies. The annuities are available to workers age 59½ and older, who will have the option of converting any portion of their savings to an annuity when they retire. Funds that aren’t converted can remain invested in the Fidelity plan.

Learning From Teachers’ Bad Experience With Annuities

Millions of educators already own annuities in 403(b) plans, the retirement accounts typically offered to public school teachers, and a lot of them would give their results a failing grade. Many school districts have turned the job of offering retirement plans over to sales agents who promote high-cost equity-indexed and variable annuities. Teachers who are unhappy with their investments often discover that moving their money to a lower-cost option will trigger hefty surrender fees.

Proponents of annuities in 401(k) plans say workers are offered plenty of protections from those types of problems. Even with the safe harbor provided by the SECURE Act, companies that offer 401(k) plans are required by law to act in the best interest of their employees, which means they must vet their plan’s investment options, including annuities.

That kind of vetting could also give annuities offered through retirement plans an edge over annuities purchased on the retail market, providers say. “Having the plan sponsor play the vetting role gives a lot of peace of mind to participants that they’re getting a good-quality annuity product,” says Keri Dogan, senior vice president of retirement income at Fidelity.

A financial planner can help individuals select annuities available on the open market, but not everyone can afford to hire an adviser, says Jeff Cimini, head of strategy and financial management at Voya Financial, which provides retirement, insurance and investment services. Annuities “are complex, and generally speaking, they’re sold, not bought,” he says.

Employees who buy annuities through their retirement plan may also benefit from institutional pricing, which means they’ll pay lower fees than they’d pay on the retail market, Dogan says. In addition, the SECURE Act mandates that annuities purchased in a 401(k) plan must be portable, which means employees who change jobs or retire can move their annuity to another plan or IRA without paying surrender charges or fees.

The Fine Print: Annuities Can Be Complicated

Although lower costs and portability could make annuities offered through retirement plans more appealing, annuities are still complex products. Fees and other expenses aren’t as transparent as they are for mutual funds and exchange-traded funds. In addition, annuities—including those offered in 401(k) plans—come in a variety of flavors. TIAA-CREF’s Secure Income Account, for example, is a deferred fixed annuity that offers a guaranteed interest rate, which currently ranges from 3.4% to 3.65%, depending on the size of the plan, with the option of converting the balance to guaranteed income after retirement. While Fidelity is currently limiting its offering to immediate annuities, it plans to add a qualified longevity annuity contract (QLAC), an annuity that starts payouts when a participant reaches a specific age, typically 80 or older. (These types of annuities require a smaller outlay of funds than immediate annuities because of the possibility that the owner will die before payments begin.) Some plans are adding variable annuities, which provide some exposure to the stock market before converting to income in retirement.

If you decide to add an annuity to your portfolio, you’ll also need to decide when (or whether) to annuitize—that is, convert it into a guaranteed income stream, a decision that’s usually irrevocable. Complicating the decision is the current interest rate environment, which could depress the size of your monthly check, depending on when you annuitize an existing investment or purchase one that offers an immediate payout. In the case of immediate annuities, for example, payments are tied to rates for 10-year Treasuries, and while those rates are higher than they were a year ago, “they’re very likely to go higher in the future,” says Harold Evensky, a certified financial planner and chairman of Evensky & Katz/Foldes Financial.

While Evensky believes investing a portion of your savings in an immediate annuity can significantly reduce the risk that you’ll run out of money in retirement, he says most retirees are better off waiting until at least age 70 to buy an annuity because payouts increase as you age. And if interest rates continue to rise, you’ll also benefit from delaying payouts.

That means leaving your funds in your 401(k) for years after you retire—something many large plans are starting to encourage. Having more assets in their plans gives employers more clout when they negotiate fees and other services with fund managers.

A Snapshot of the Future?

Under a provision in the SECURE Act, companies are required to include an illustration in their retirement plan’s quarterly or annual statements that estimates the amount of monthly income your balance would provide if you were to convert the funds to an annuity. While these illustrations could raise awareness about the value of annuitizing retirement income, retirement experts say they’re primarily useful for older workers who have accumulated a significant balance. Without supplemental tools, such as projections of how much additional contributions would add to the balance, younger workers or new plan participants could end up with a “discouraging picture” of the amount of guaranteed income their savings would buy, the Insured Retirement Institute, a trade association, wrote in a comment letter to the Department of Labor.

Annuity providers are hopeful that the DOL will allow plans to include future contributions, company matches and investment returns in the income estimates. Participants in the Thrift Savings Plan, the federal government’s version of a 401(k) plan, already receive those kinds of projections in their plan statements, says Paul Richman, chief government and political affairs officer for the IRI. ■

Immediate Annuities

Annuity Income Projection

Retirement plan providers will soon be required to provide employees with an estimate of the amount of monthly income their current 401(k) balance would provide if they were to purchase an annuity that provides payouts immediately. The example below assumes the participant and the participant’s spouse (in the case of a joint life annuity) will be 67 on December 31, 2022.

Current account balance: $125,000

Single life annuity: $645 per month

Joint life annuity: $533 per month for participant’s life; $533 per month for spouse following participant’s death

learning the Lingo

Types of Annuities

Here are some varieties of annuities that may be offered by your 401(k) plan:

Single-premium immediate annuity. Also known simply as an immediate annuity, you typically give an insurance company a lump sum in exchange for monthly payments for the rest of your life or for a specified period.

Deferred fixed annuity. These annuities offer a guaranteed interest rate over a specific period and can be converted into an income stream in retirement.

Qualified longevity annuity contract (QLAC). A type of deferred annuity that’s funded with assets from your IRA or 401(k). You can invest up to 25% of your account (or $145,000, whichever is less) in a QLAC, and the funds will be excluded from the calculation to determine required minimum distributions. When you reach a specified age, which can be as late as 85, the funds will be converted into payments guaranteed to last for the rest of your life. The taxable portion of the money you invested will be taxed when you start receiving income.

Variable annuity. A type of deferred annuity that invests in mutual-fund-like subaccounts to create future income (usually in retirement).