Risk vs. Readiness: The 401(k) Plan Annuity Conundrum

Employers are considering in-plan annuities, but hurdles remain

By Joanne Sammer Feb 21, 2018

Annuities offer a guaranteed stream of retirement income that can provide life-long financial security. Yet fewer than 10 percent of plan sponsors have made any move to include annuities as a 401(k) investment option.

That hasn't dampened the enthusiasm of annuity advocates, who want to see these products used to make a defined contribution plan operate more like a traditional defined benefit pension plan.

In its 2015 guidance, the Department of Labor (DOL) addressed how plan sponsors can meet their fiduciary responsibilities when choosing an annuity provider, thereby creating a "safe harbor" from litigation. A year earlier, the DOL issued a rule to make it less risky for plans to include longevity annuities, which hold off making payouts until retirees are in their seventies or older.

Under President Donald Trump's administration, Treasury Secretary Steve Mnuchin released a report last fall that "recommends strengthening consumer access and choice with respect to annuities within employer-sponsored retirement plans."

While more retirement plans are allowing participants to purchase shares in an annuity—just as they would buy shares in a mutual fund—the numbers aren't yet impressive. The 2018 Defined Contribution Trends report by Callan, an institutional investment consultancy, showed that among 152 plan sponsors polled last fall, 8.9 percent offered an in-plan annuity, up from 4.6 percent in 2015.

Similarly, the Society for Human Resource Management's (SHRM's) 2017 Employee Benefits survey report found that 9 percent of HR professionals polled last year offered an in-plan annuity. (This was the first year SHRM asked its members this question).

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Taking the Plunge

Some employers have put annuities front and center in their 401(k) plans. United Technologies Corp., for example, makes an annuity its qualified default investment alternative (QDIA)—the investment where the company automatically directs newly enrolled employees' contributions unless an employee opts out.

However, the firm's experience also illustrates how complicated annuities can be for plan sponsors. For one thing, the company worked with service providers to design its own annuity products for the plan.

"United Technologies has built a strong and diligent governance process for this, but most companies don't have the resources to do that," said Robyn Credico, a senior consultant with Willis Towers Watson in Washington, D.C.

Target-date mutual funds with an annuity feature could be an option for plans that aren't jumbo sized. However, informal guidance from the DOL in 2016 stated that target-date funds that include annuities do not provide enough liquidity to participants for them to be used as QDIAs for automatically enrolled participants.

[SHRM members-only toolkit: Designing and Administering Defined Contribution Retirement Plans]

Does Risk Outweigh Readiness?

"Plan sponsors don't want to look too different or out of line," said Bob Melia, executive director of the Institutional Retirement Income Council in Iselin, N.J., an organization of industry advisers. "They are concerned that it could draw scrutiny that could manifest into lawsuits."

Melia considers this attitude to be short-sighted. After all, retirement plans exist to help employees save for retirement and employers to manage their workforces by helping older workers retire when they need to, making way for younger employees. Allowing retirement plan participants to invest in annuities is one way to help achieve those goals.

Yet fiduciary risk still looms large. Because annuities must pay out over the lifetime of the purchaser, "plan sponsors have to select a provider that will be able to pay benefits for a long time," Credico said. To pay out all the benefits involved, "that provider needs to be around for 100 years."

These concerns were voiced in an August 2016 report by the U.S. Government Accountability Office (GAO), which found that plan sponsors were looking for more-specific guidance and stronger litigation safe harbors from the DOL before offering annuities in a 401(k) plan. The GAO, for instance, called the DOL's 2015 guidance on choosing an annuity provider too vague, with a lack of specific definitions for practices that might ensure liability protection, such as providing "sufficient" information and "appropriately" evaluating annuity providers.

Costs and Complexity

Annuities present some hurdles for plan sponsors when it comes to plan administration and managing costs for the retirement plan and its participants, such as:

  • Recordkeeping challenges involved in adding annuities to a 401(k) plan. Because annuities involve insurance contracts that are not easily exited, there is no clear way to move participant investments in these products from one employer plan to another when employees change jobs.
  • Changing retirement plan service providers. There needs to be some way for in-plan annuities to move smoothly over to a new service provider or, if that's not possible, to automatically roll over to the insurance company offering the annuity contract.
  • Keeping investment fees in check. Although plan sponsors often can provide annuities that are less expensive than what individual participants could purchase on their own, these products are still likely to charge higher fees than the other investments a plan offers.

Weighing Alternatives

Employers that are not yet ready to offer an annuity in their 401(k) plans can help retiring employees to roll 401(k) funds into an annuity outside of the plan. Callan's survey showed that 8 percent of plan sponsors helped put new retirees in touch with annuity placement services last year, up from 3.8 percent in 2016.

If the company's workforce is large enough, the employer can negotiate with annuity providers to offer lower fees in exchange for access to plan participants.

At the very least, employers can provide information about how an annuity could fit into employees' retirement plans.

Joanne Sammer is a New Jersey-based business and financial writer.


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