It's easy to forget that 401(k)s and similar employer-sponsored retirement plans are relatively new phenomena. Until the early 1980s, anyone who had a retirement plan through work likely had a pension of some kind. Not only are 401(k) plans now the norm, but they continue to evolve. A Roth contribution option has been added to many plans, where you contribute post-tax instead of pre-tax funds, and auto-enrollment and target-date funds have become mainstream plan features. Now as attention turns to guaranteed retirement income streams, could the opportunity to invest in an in-plan annuity be the next big thing?
The government, employers, retirement plan providers and the insurance industry have, at different times, called for ways to provide retirement investors with some guarantees. We continue to hear rumblings about the idea of annuities adding certainty to 401(k) plans, but would they? As the chatter about annuities has grown louder, so has the opposition.
The many arguments against annuities in 401(k)s include the following:
- An annuity is only as safe as the insurance company that sells it, so if they go out of business, guess what? Suddenly your guarantee isn't absolute.
- Annuities are associated with high fees.
- Not only can annuity contracts be complicated and difficult to understand, but the large number of products with varying benefits can be confusing.
- Annuities generally aren't portable. So if you leave your employer, depending upon your plan rules, you may either have to surrender it — and pay potentially steep surrender costs — or leave it in your old employer's plan.
- The potential tax benefits of an annuity are somewhat negated, as those tax benefits are already present in a 401(k).
- Many people worry that placing most or all of their retirement savings in a single product is too risky.
Despite such concerns, the guarantees that many annuity products pitch continue to draw interest. A May 2012 survey of 500 large U.S. employers found that 16 percent already provided their 401(k) participants with access to a guaranteed retirement income stream, and the numbers are growing.
Recently, Sen. Orrin Hatch, R-Utah, introduced a bill called Secure Annuities for Employees (SAFE) Retirement Act of 2013. In its current form, the proposed legislation paves the way for more annuity options in 401(k)s and addresses the issue of portability — proposing that individuals who separate from employment be allowed to roll any annuity held in a 401(k) plan into an IRA. SAFE faces a long road through Congress, but if it does eventually pass, we're likely to see an explosion in 401(k) annuity investments.
If you find yourself faced with the decision of whether or not to allocate a portion of your retirement savings to an in-plan annuity, ask yourself these questions:
- Are the fees too high for what you get, or are they reasonable and within the industry's standard range?
- What is the credit rating of the company offering the annuity? You should only purchase insurance products like annuities and life insurance from highly rated, highly solvent companies.
- What are the surrender charges, and how are they structured? Does the surrender schedule fit with your current situation, potential needs and timeline for keeping the annuity?
- Can you maintain the contract even if you leave your current employer? Would you be allowed to leave the annuity within your 401(k)?
- Do you understand all the benefits, risks, fees, and various bells and whistles in your annuity contract? If you're not sure you both need and understand something, don't buy it.
Annuities might look attractive on paper, although I would strongly advise caution. Like all things investment-related, do your homework. At the very least, speak with a financial advisor or your 401(k) administrator to find out if an annuity has a place in your investment strategy before jumping in head-first.
Scott Holsopple is the president of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal.