Looking to Hit the Bullseye: Annuities in Target-Date Plans

By Patty Kujawa

Dec. 23, 2014

People are living longer. And the days when workers received a defined benefit annuity package from their company are long gone.

As a way to help protect workers from outliving their retirement savings, the U.S. Treasury Department and Department of Labor issued coordinated information to encourage companies to offer special target-date funds in their 401(k)s that include delayed annuity payouts.

“As boomers approach retirement and life expectancies increase, income annuities can be an important planning tool for a secure retirement,” said J. Mark Iwry, senior adviser to the secretary of the treasury and deputy assistant secretary for retirement and health policy. “Treasury is working to expand the availability of retirement income options for working families.”

Typically, workers get a lump sum payout from their 401(k) when they retire, and it’s up to them to make that money last. With target-date fund annuity programs, participants under age 55 hold typical fixed income investments in their target-date annuity fund. When they turn 55, those fixed income assets are used to purchase annuity contracts. Workers still get a lump sum, but part of their entire retirement account comes in the form of guaranteed lifetime payments.

It’s not exactly the 100 percent guaranteed monthly payout workers once received, but the option is available with a little more guidance for plan sponsors to offer.

Including deferred annuities in 401(k)s hasn’t been very popular because up until now, plan sponsors had questions about the products and the degree they’d be held accountable for the investment.

The difference today is that the Treasury Department said plan sponsors wouldn’t break certain fairness rules if they offered these specific target-date funds to older participants only. The Labor Department followed up by adding plan sponsors can automatically enroll participants in these investments and won’t get into any trouble if certain steps are followed. Plan sponsors can also use annuity target-date funds as regular investment options as well.

“We are very happy that the government continues to regulate the importance of [retirement] outcomes,” said Sri Reddy, head of full service investments at Prudential Retirement. “The more clarification, the better off the marketplace is going to be.”

Under normal rules, 401(k) plans can’t offer one type of investment to a specific group of people without offering it to everyone. The new rule says that if four detailed requirements are met, plan sponsors can do exactly that when it comes to the 55-year-old participant in the target-date fund annuity program.

The Labor Department complemented the Treasury’s ruling by saying that if certain conditions were met, they could use the investment to automatically get workers started in the company 401(k) plan, similar to target date and other options that were sanctioned by a 2006 federal law.

Target-date funds took off when the 2006 rule was passed and several observers said this new clarification might similarly pave the way. According to the latest data available from the Investment Company Institute, about 41 percent of 401(k) participants had a target-date fund in 2012, compared with 27 percent in 2006. 

But plan sponsors have had little appetite for annuities, often called lifetime income products, in 401(k) plans. According to a November survey by benefits consultancy Towers Watson & Co., only 12 percent of plans offer lifetime income, and within that circle, only 5 percent of participants use them.

In the past, plan sponsors have also complained about pricing and complications with communicating the annuity to participants. Plus, there’s plenty of fiduciary risk to consider, like what happens if the insurance company providing the annuity goes belly-up.

“There has not been much traction to date,” said Robyn Credico, defined contribution practice leader at Towers Watson. “Employers’ number one reason [for not offering] is that employees aren’t asking for them. Fiduciary exposure in selecting an annuity provider has been pretty significant too.”

Many industry groups responded positively to the announcements, but it’s still unclear whether plan sponsors will start offering the target date annuity investment. Marrying annuities to the very popular target date fund might spur interest, but it will take time and more products on the shelf for plan sponsors to consider, said Bill Charyk, president of the Institutional Retirement Income Council.

“The new rules are a good start,” Charyk said. “They addressed some of the practical concerns plan sponsors have.”

Patty Kujawa is a freelance writer based in Milwaukee.

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