The new conversation around annuities in the workplace

Nobel prize-winner (and our co-founder) William F. Sharpe called decumulation the “nastiest problem in finance.” A recent study by Greenwald Research revealed that 70% of plan participants are worried about running out of money in retirement. Transforming savings into a steady stream of income that will last their lifetime is an enormous undertaking for most near-retirees.

Solving for this problem is the holy grail for employers, the financial services industry and policymakers. Both bipartisan SECURE Acts (“Setting Every Community Up for Retirement Enhancement Act”) enacted into law included some of the biggest changes to the retirement system in decades, including key provisions that ease the fiduciary burden on plan sponsors when selecting, reviewing, and monitoring annuities and annuity providers.

The topic of annuitization comes with a wide mix of considerations. For some, annuities represent a clear path to guaranteed retirement income. For others, they can raise concerns about commissions, complex features and disclosures, and the solvency of the insurer. And for most, it is all these things.

With the legislative changes, a growing number of employers will be weighing the possibility of adding annuities to plans, but the jury is still out on whether SECURE will lead to sweeping changes to retirement benefits offerings. However, with rising inflation and market instability, employer conversations about annuities in the workplace will most likely increase.

Annuities can be a useful component of a holistic retirement plan. However, given their complexity, it needs to be a highly personalized decision factoring in the individual’s circumstances and goals.

Here are some of the important considerations for both employees and employers:

Employer considerations 

Plan sponsors face a plethora of questions, considerations, and decisions, including:

• Deciding on types of annuities to be offered (immediate annuity, deferred income annuities/fixed deferred annuities, variable annuities, etc.), factoring in the liquidity and surrender period of the contract and any associated penalties participants may face
• Evaluating annuity providers and the products on costs, complexity, and credit risk
• Understanding the employer’s responsibilities related to negotiating better annuity rates, reporting requirements, and ongoing monitoring of the provider and products
• Assessing how annuities will be offered – only as a choice, a default option, or through a professionally managed account – and understand the implications of each

Employee considerations

Employees who have annuity options on their 401(k) platforms face a number of complex decisions:

• Evaluating if an annuity is needed in their retirement portfolio and, if yes, the most suitable type and age to annuitize
• Identifying and evaluating trade-offs and benefits when allocating to annuities relative to other simpler and more liquid retirement income options
• Understanding the complexity of annuity product features and how they are priced
• Calculating how much to allocate to an annuity product
• Assessing level of comfort giving up control of assets (restricting access to future liquidity)
• Understanding the liquidity of the contract as well as any penalties associated with cancelling the annuity contract early
• Determining which payout option to select and why (single versus joint versus survivor benefit, period certain, etc.)

 Raising the standard for retirement help

For plan sponsors offering annuities, it’s critical to provide a comprehensive retirement education program for near-retirees alongside any annuity option that provides personalized advice. Given the complexities of annuities and the uniqueness of each near-retiree, providing participants access to a retirement income review with an independent advisor – who is free of product conflict – is essential to good decision making and participant success. Best practice retirement income reviews include:

• Guidance on diverse types of annuities, associated costs, and other critical considerations, such as giving up control or liquidity, and deciding how much to allocate to annuities and at what age
• Evaluation of annuitization decisions in the proper holistic context of household retirement plans:
• Coordinating with defined benefit pension payout election (annuity or lump sum)
• Ensuring participants are aware that the most attractive annuity is the annuity implicit in delaying Social Security claiming

Personalized managed accounts are in an ideal position to create retirement income focused investment strategies provided they are able to reach a broad range of employees and retirees. According to Cerulli Associates, 95% of DC recordkeeping platforms offer managed accounts. Because of their accessibility and personalized approach, managed accounts that offer access to an independent advisor are a natural building block to help navigate the complexities of annuities and all the other interrelated financial decisions near-retirees face.

Related: Retirement insecurity: Pre-retirees less confident they can cover basic living expenses

It may take years to assess the full impact of SECURE on annuities in workplace retirement planning. For now, it is important to acknowledge the key role comprehensive retirement help and access to advisors – free of product conflict – play in providing both plan sponsors and employees more comfort with retirement income products in the workplace.

Kelly O’Donnell is the executive vice president and co-chief client officer at Edelman Financial Engines.