A recent survey and subsequent white paper recently showed that 81% of 401(k) participants were at least somewhat interested in a retirement plan that puts guaranteed income on the table. While the survey was careful in only use the phrase “lifetime income,” the primary way to achieve this is by offering an annuity option in the 401(k) plan.
Annuity products come in a wide variety of styles, and likewise, investors have a wide variety of perceptions of the products. The basic principle for annuities is that you pay a premium in exchange for future periodic payments. The payments may begin immediately or at a future date and can continue throughout your lifetime. Any guarantees are backed only by the claims-paying ability of the issuing insurance company.
The SECURE Act made it easier for plan sponsors to add annuities to retirement plans with safe harbor provisions. But, like many options in life, we must understand: Just because we can, doesn’t mean we should. Plan trustees may want to offer as many options as possible for their plan participants, but they should look closely at the participant demographics to determine if an annuity option would be good for the plan. Having more options does not mean participants will make the right decision for their investments. Part of the fiduciary duty is to limit the choices to investments that will benefit the characteristics of the plan participants.
Annuities come with a certain amount of fees and expenses, and with lower interest rates, money may grow more slowly than if it were invested in mutual funds or exchange-traded funds. Where should the line be drawn regarding appropriate investment options? Do we allow cryptocurrencies or speculative investments like SPACs, NFTs, or cannabis stocks? Opening the door to annuities in defined contribution plans also raises many questions regarding the fiduciary responsibility of plan trustees. With an annuity, an investor trades higher fees and often less than market returns for the guaranteed income. To receive the inflation protection guarantee, investors may have to purchase a rider, a separate policy provision, which increases the cost.
Investors can create a similar “lifetime income stream” with an investment portfolio of stocks, bonds, and mutual funds that can be passed down to heirs rather than stopping when the investor dies. In our opinion, 81% of plan participants may want a “lifetime income” stream, but don’t understand how it works. Putting already tax-deferred funds into a tax-deferred annuity yields no additional benefit. Furthermore, annuities lock up funds for a period of time, reducing the options for loans or early withdrawals.
Annuities are not a financial plan, but products used inside a structured plan to minimize an identified risk. Annuities are still investments, and as with all investments, there are inherent risks. Annuities should be measured for their “risk transfer.” If an investor can transfer an identified risk for a fair return, it is, generally, considered to be a good trade.
One other thing to keep in mind: Insurance companies sell annuities. Many of the largest custodians for 401(k) plans are also insurance companies. Knowing this, you need to ask who ultimately benefits from offering annuity options in a 401(k) plan?
If you have questions on the investment options available in your 401(k) plan, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
