Shifting the 401(k) savings conversation to guaranteed income

After the challenges of 2020, Americans are thinking more urgently about their financial security. While last year turned out to be a strong year for markets, it certainly didn’t look that way in March, as major indices experienced the fastest-ever decline into bear market territory.

The challenge and economic turbulence of 2020 was unsettling for people planning for retirement and already in retirement — which makes this a good time for your clients who sponsor 401(k) plans to ask how they can offer participants additional ways to protect themselves from economic uncertainty. Guaranteed lifetime income products such as annuities may be part of the answer.

Annuities are rare in 401(k) plans — only about 5% of 401(k) plans provide an in-plan annuity option, according to Willis Towers Watson. But thanks to the Secure Act, which became law in late 2019, annuities should become easier for 401(k) sponsors to offer in coming years.

As plan sponsors think about how to incorporate annuities into their offerings, they may want to look to the 403(b) world, where in-plan annuities have been incorporated for decades, are much more common and can prompt better investor behaviors. Employees are more likely to annuitize in retirement and can be more cost-effective, if they save through an annuity during their working years, thanks in part to institutional pricing models.

The ‘personal pension’

The 403(b), which offers tax-advantaged retirement saving for people in the nonprofit sector, is actually older than the 401(k). It was established in 1958, for the express purpose of giving employees a way to generate a personal pension to complement Social Security.

In-plan annuities help 403(b) plan sponsors achieve that goal. Workers can contribute to an annuity throughout their saving years, building a source of guaranteed income that provides a permanent paycheck in retirement.

Given the 403(b)’s well-established focus on retirement income, it’s not surprising that 403(b) plan sponsors prioritize participants’ ability to generate adequate income in retirement. According to a recent survey of plan sponsors conducted on behalf of TIAA:

• 403(b) sponsors are more likely than 401(k) sponsors to say that ensuring employees will have sufficient retirement income is a top reason for offering a retirement plan (53% vs. 35%).

• 403(b) sponsors are more likely to consider participants’ retirement income-to-replacement ratio (41% vs. 21%) and retirement readiness (37% vs. 19%).
• 401(k) sponsors are more likely than 403(b) sponsors to look at participation rates (41% vs. 18%) and contribution rates (37% vs. 19%) when assessing the effectiveness of their plans.

Benefits for participants

Participants with annuities think their retirement plan works well for them. In the TIAA-sponsored survey, 80% of plan participants who reported having a guaranteed lifetime income annuity said they were highly confident that they were making progress toward achieving their long-term financial goals. Just 45% of the participants without guaranteed lifetime income said the same.

It’s true that anyone — including 401(k) and 403(b) participants — can purchase an annuity by drawing on their accumulated savings at retirement. But contributing to an in-plan annuity comes with advantages. Thanks to economies of scale, in-plan annuities are typically offered with no riders and with lower fees than if a retiree was buying an immediate annuity at the time of retirement. Also, by contributing to the annuity over many years, savers can benefit from higher returns and reduced interest rate risk.

The outlook

Offering in-plan annuities also helps plan sponsors set the expectation that retirement income — rather than simply asset accumulation — is the goal of saving for retirement. This, in turn, can help overcome the inertia barrier that leaves too many people without adequate guaranteed income.

To be sure, a guaranteed lifetime income option shouldn’t be the only product in a retirement plan. Balance and diversification are key to any portfolio. By directing a portion — say 20% — of their regular retirement plan contributions to an annuity, participants may be able to take advantage of more aggressive growth opportunities while building a source of guaranteed income they cannot outlive.

Hopefully, the Secure Act’s provisions expanding access to in-plan annuities will shift the retirement savings conversation toward ensuring that participants achieve adequate retirement income. Just as the Pension Protection Act of 2006 made target date funds the new default and moved the dial on accumulation, the Secure Act could make annuities a much more common option for 401(k) plans and move the dial on providing participants with secure income.

The result could be a surge of retirement confidence among 401(k) savers.

Ben Lewis is senior managing director, institutional retirement, at TIAA.