Why do so fews retirement plans offer lifetime income solutions?
by Burke JohnsonMr. Johnson is Executive Vice President / Chief Operating Officer for LT Trust. Visit www.lttrust.com/.
Annuity……one mention of that word elicits a wide range of opinions such as guaranteed income, rip off, safety net, or “Suze Orman said annuities are bad.” The truth is that annuities have historically played an important retirement planning role for Americans but have seen limited adoption in employer sponsored retirement plans.
According to the Plan Sponsor Council of America, fewer than 10% of workplace retirement plans offer lifetime income solutions.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act that was passed with bipartisan support and became effective January 1st, 2020, included a “safe harbor” provision to make annuities more accessible in 401(k) plans. Typically, an annuity would be purchased when someone retires to ensure income for their lifetime, so why would they be offered in an employer sponsored 401(k) plans?
Purchasing an annuity within a 401(k) plan may make sense for a participant nearing retirement who wants to lock in some of their investment gains with a small percentage of their account balance to hedge against a market decline and/or outliving one’s assets. This is especially true in today’s times when the market is near an all-time high. However, we do not foresee a significant increase in the number of plans offering annuities for several reasons.
1) Participants Don’t Have Enough Money To Purchase Annuities
Most participants have the bulk of their retirement assets outside of their current employer’s 401k plan when they reach retirement age. Purchasing an in-plan annuity only makes sense for participants who have the majority (if not all) of their tax deferred assets in their current employer’s retirement plan – this is extremely rare.
According to Forrester Research, today’s youngest workers will hold up to 15 jobs over their lifetime. When participants change jobs, they are more likely to roll their retirement account into an IRA instead of into their new employer’s plan. At LT Trust, our plans see 2.1 rollovers out of the plan for every rollover into the plan and in dollars equates to $2.60 leaving the plan for every $1 rolling into the plan. Furthermore, our average participant balance is $46,500. According to ImmediateAnnuities.com, this would only yield $225 in lifetime income with the purchase of an immediate annuity for a 65-year-old male living in Colorado.
2) They’re Too Complicated To Understand
There are too many types of annuities to just include one in a plan, such as immediate, deferred, fixed, variable, joint and survivor, etc. How is an advisor to select the most appropriate annuity for the plan since every 401k participant has a unique financial situation?
At the same time, if only a single annuity option is available, a participant would be better off taking a distribution and then purchasing any annuity available in the marketplace that factors in their unique situation. Specifically mentioned within the SECURE Act, qualified longevity annuity contract (QLAC), is a type of advanced life deferred annuity funded with an investment from a qualified retirement plan, such as a 401(k) or IRA is a “one size fits all approach” and assumes all plan participants have similar circumstances.
In addition to the complexities of all the different types of annuities, it is also difficult to understand how an annuity should fit within your allocation vs. other investments. One thing that is unclear is if annuities within 401k plans are meant to be purchased via payroll deduction as an allocation next to mutual funds or must be purchased as a lump sum. If annuities are allowed as an allocation, what asset classification would these be? Conventional wisdom stresses the use of a glide path toward retirement, with investments becoming more conservative as the participant ages.
So, the question then becomes, which asset class should the participant reduce their exposure to if they allocate a certain % of their contributions to an annuity? Advisors would have to be heavily involved with educating individual participants about annuities if available within the plan. This may deter advisors more than ever to service retirement plans.
3) They’re Expensive
According to the Department of Labor, a 1 percent difference in fees and expenses could reduce your account balance at retirement by 28 percent.
According to annuity.org, average fees on a variable annuity are 2.3 percent of the contract value and could be upwards of 3 percent. However, within a 401(k) plan, the cost could be lower because a commission will not be paid to an insurance agent. Even with a reduced expense without a commission payment, annuities are still much more expensive than the average 401(k) mutual fund expenses according to napa-net.org:
- .39% Stock or equity funds
- .35% Bond funds
- .46% Hybrid (balanced/target date)
The longer a plan participant invests in an annuity, the greater the negative impact of fees will have on their retirement assets. Part of the expense of an annuity can be viewed as the cost to provide tax-deferred growth. However, defined contributions plans already provide the same thing, so by purchasing an annuity within a retirement plan, you are paying a premium without realizing any additional tax benefit.
4) Portability Is A Challenge
Annuities are notorious for locking in investments for a long period of time unless an account holder pays a contingent deferred sales charge (CDSC). The SECURE Act attempts to make annuities portable so the participant could rollover to an IRA or another qualified plan without paying surrender charges.
There is a catch though; the new provider would have to support the annuity. If you purchase an annuity within a 401k plan with an insurance company recordkeeper and the plan moves to another insurance company recordkeeper, it is\ unlikely the new recordkeeper will support their competitor’s annuity. There has been no official guidance on how this will work.
5) They Introduce Recordkeeping Complexities
How are recordkeepers and TPAs going report assets used to purchase an annuity on the Government Form 5500 tax filing? Are they to report cash value or book value? If a participant purchases a $100,000 immediate annuity, what is the value of that asset on this year’s 5500? What about next year and the year after that? What about a deferred variable annuity? Is each recordkeeper/TPA going to be allowed to use its best judgement for reporting present value of annuities?
Assessing fees against annuities is another unknown. How are recordkeepers and advisors going to assess asset-based fees against these investments, especially if the annuity product is not proprietary to the recordkeeper. If a fee cannot be assessed, advisors may be less inclined to include them in a plan’s lineup because it will lower their compensation. Further complicating matters, open architecture recordkeepers must rely on trading platforms (Fidelity, Broadridge/Matrix, Schwab, Mid-Atlantic, etc.) to support annuities for transactions to be automated, which is an absolute requirement if the annuity is meant to be purchased consistently through payroll deduction.
What Is The Bottom Line?
The SECURE Act has been a step in the right direction when it comes to policy that makes saving for retirement more accessible to everyone. Annuities can play a vital role in a retirement income strategy. However, because there are more questions than answers regarding how annuities will work in 401k plans, I see all stakeholders shying away from their
First, I think most advisors will continue utilizing traditional fund lineups that both Plan Sponsors and participants can understand. Second, I believe non-insurance company recordkeepers will not want to support annuities because of the additional challenges without additional revenue. Finally, participants are better off taking a distribution from their 401(k) plan at retirement and purchasing an annuity directly from an insurance company.