Over the past decade, 401(k) plans have replaced pension plans as the primary retirement savings vehicle, which has given participants more responsibility over saving and investing for their own retirement. And that also means they’re responsible for making sure their savings are sufficient to last through the rest of their lifetime — a fairly new concern, considering the pension plans of the past provided retirees with a fixed monthly income stream.
To help participants shoulder these tasks, plan sponsors and legislators are turning their focus from the accumulation stage to the decumulation stage of retirement planning — although some would argue there is still a lot of work that needs to be done with respect to saving activity. According to a recent study by Northwestern Mutual, the average American has $84,821 saved for retirement, which is far less than the amount industry leaders and financial professionals recommend.1
In-Plan Annuities — A Potential Solution?
Legislators hope to assist with the savings shortfall by smoothing the way for plan sponsors to offer in-plan annuities. Having an annuity option replicates that portion of a defined benefit plan which annuitizes the balance and produces a monthly income stream and thus ensures the annuitant is paid a fixed dollar amount, usually for their lifetime beginning at retirement. You can think of this fixed dollar amount as a type of “forced budget” — it takes the guesswork out of calculating how much you should take as monthly income, rather than forcing you to cash out and figure out how you will stretch your money.
The industry and legislators have kicked around in-plan annuities for years, but plan sponsors dismissed them as too risky, believing the vehicles would expose them to greater fiduciary responsibility. Not to mention, many plan sponsors don’t have the resources to adequately and prudently select from the various insurance companies and types of annuities available in the marketplace.
The U.S. Department of Labor (DOL) issued its first bit of safe-harbor protection in 2008 and focused on selecting sound, reputable annuity providers (insurance companies) for plan sponsors to consider. The DOL recommended that sponsors thoroughly research annuity providers and their financial security, among other items. Plan sponsors aren’t eager to take on this due diligence and responsibility, especially when participants aren’t asking for it. Not surprisingly, the adoption of in-plan annuities has been low — the Profit Sharing Council of America’s 2016 study revealed that only 10% of plans offered a guaranteed retirement income product.2
What’s the Future of In-Plan Annuities?
More recently, Congress proposed the 2018 Retirement Enhancement and Savings Act, which appears to have bipartisan support and helps protect sponsors from potential liabilities in case an insurer is unable to make payments, though it still holds plan sponsors liable for selecting the insurer.
While in-plan annuities are conceptually appealing, they do have critics. Annuities can be very confusing and sponsors may run into challenges when it comes to educating participants about how they work. Plan advisors already have had a tough time educating participants about investments, which has contributed to the popularity of target-date and asset allocation funds that involve little to no education. In addition, participants may not want to give up the investment control and illiquidity that come with annuitization. And if a participant wants to annuitize, they can do so outside of their 401(k) plan through an IRA.
Many plan sponsors don’t like the idea of taking on more fiduciary responsibility, especially when it pertains to a subject they may only have cursory knowledge about. Annuities also have an undeniable stigma, due to their historically high expenses, lack of portability and complexity.
Sometimes, participants are better at knowing what they want and not necessarily what they need. With insufficient savings a top concern for many retirees, a forced budget in the guise of an annuity just might be a solution.
Ready to create a well-structured, competitive retirement plan for your business? Contact us to find out more on how you can bring greater peace of mind and sustainability to your team in a future where Social Security and pension plans aren’t enough.