Annuities in 401(k) Plans Are on the Decline

Plan sponsors have slowed down on offering annuities to 401(k) plan holders.

Annuities and 401(k) plans have reached a plateau in their relationship, and a range of administrative and legal challenges can be attributed to this slowdown.

Principal and chief investment officer Philip Chao of Chao & Co., an advisory firm, says at his company, they’re “still at the margins.”

In 2014, the Treasury Department announced a set of rules designed to promote the use of longevity annuities within 401(k) plans. The plan was set up to increase access to a guaranteed source of income for retirees who had experienced a decline in access to pension plans. In that same year, the Treasury Department also authorized annuities to be used in target-date funds in 401(k) plans, regardless of whether or not that fund was a part of a plan’s default investment option.

Despite allowing individuals to access their 401(k) plans through regular withdrawals, and not just in one lump sum, and other retirement-income plan improvements, the rise in annuities has remained low.

Consulting firm Willis Towers Watson recently released a new survey that revealed that 30% of 401(k) plan sponsors offer some form of lifetime-income solution for their plan members. Nonetheless, the vast majority still didn’t use annuities. Instead, 70% offered education and planning tools, and nearly 90% offered systematic withdrawals.

Less than 20% of funds offer a built-in annuity element, including a TDF; 15% use a third-party platform to connect participants out-of-plan annuities, and 15% offer a deferred annuity as a separate investment option.

In the few years since the survey was released, the use of lifetime income options has actually increased by seven percentage points. Yet consultant at Willis Towers Watson Dana Hildebrandt says that the majority of that increase seems to have been from noninsurance options. She said it “seems like people have adopted the low-lying fruit and nothing in terms of meaty solutions.”

One of the biggest obstacles seems to be the safe harbor, a legal barrier perceived by sponsors to adding annuities to 401(k) plans. The safe harbor standard protects plan sponsors from legal risk while at the same time deeming them responsible for projecting an insurer’s wealth many years away.

The SECURE Act, current legislation in Congress, would make the safe harbor more appealing to plan sponsors. Despite overwhelming approval in the House, the SECURE Act stalled in the Senate, yet there is hope that it will pass in the fall after being attached to budget legislation. Mr. Chao says that many companies are waiting for the law pass to give them a safe harbor, but until then, nothing is going to change.

Target-date funds, or TDFs, are the most popular of the 401(k) plan investments. This popularity can be attributed to the safe harbor regulations around qualified default investment alternatives that were issued in 2007 by the Labor Department. According to Morningstar Inc., TDFs amounted to $1.7 trillion at the end of 2018.

Despite all of this, the safe harbor wouldn’t automatically cause an increase in annuities. There are other significant issues that the industry still needs to solve, such as the fact that plan holders can’t roll an annuity over to a new employer’s 401(k) plan, and record keepers can’t all administer annuity products.

According to the Willis Towers Watson survey, low demand from individuals and administrative complexities are two of the main challenges for insurance-backed 401(k) products offered by plan sponsors. Ranking third is a fiduciary risk, which would be remedied by a safe harbor.

Mr.Chao still believes that regardless of the challenges and less than ideal circumstances, annuities should be considered among the options for participants. Annuities would still be a valuable addition to the traditional plan design, which leaves retirees with two options; deal with limited options for distribution while leaving money in the plan or compile money into a more expensive retail annuity option.

The industry is not all in agreement over the potential benefits of annuities on the retirement-income situation, however. Director of the Pew Charitable Trusts retirement savings, John Scott, explains low median account balance to prove that annuities don’t always add value. According to Vanguard Group data, retirees who were over the age of 65 maintained a median account balance of $58,000 at the end of 2018. Mr. Scott says this is not a lot of money to annuitize when taking into consideration other retirement expenses such as unanticipated financial needs, health care, and long-term care. What would make more financial sense is for participants to withdraw from their 401(k) plan early on in retirement to delay claiming Social Security for as long as possible, said Mr.Scott. This is advised because this would allow retirees 8% more each year in Social Security payments. Because Social Security is a form of an annuity, 401(k) plan holders may not actually require any additional annuities.

He added that it’s not quite as simple as it may appear and that the decision to add an annuity to a plan is not one that should be taken lightly.