In-plan Annuities: A Solution for Retirement Income Security?

Although they have not yet taken the retirement plan market by storm, so-called “in-plan annuities” are gaining acceptance among 401(k) plan sponsors. Annuities are insurance products that payout income in the future, and are popular for those who want a steady retirement income stream. Whether in-plan annuities can fit into your qualified retirement plan is a question you may want to consider.

What Are the Numbers?

In 2014, a life insurance industry data-gathering organization (“LIMRA”) reported that total assets covered by an in-plan guarantee grew 31% during the previous two years, even though the actual dollars — about $3 billion — represent just a small fraction of the 401(k) asset universe. Also, while approximately 2.3 million plan participants have an in-plan annuity option available to them, the proportion who has actually utilized that opportunity is small. With this type of growth, in-plan annuities may become a fixture on the 401(k) landscape.

The trend is likely to be bolstered by IRS Notice 2014-66, published in October 2014, giving this agency’s stamp of approval for in-plan annuities to be used as a component of a target date fund. This means these investments can become part of a qualified default investment alternative. With an annuity element automatically built into the investment lineup, many participants could wind up with an in-plan annuity absent an affirmative action on their part to reject it.

What Are the Choices?

In-plan guaranteed alternatives generally consist of three types of annuity formulas:

  1. Deferred fixed annuity. This is the simplest choice. Plan participants purchase the annuity contract with their regular plan contributions. The formula calculates the guaranteed future income based on the interest rates and actuarial assumptions in place at the time of each contribution. The participant must begin taking the annuity at retirement. If he/she dies before the annuity is fully distributed, his/her heirs may not recover any of the “wasted” contributions. By the same token, if the retiree lives to 100 years, he or she comes out ahead of the game.
  2. Guaranteed minimum income benefit (GMIB). To limit the risk that the interest rate and actuarial conditions will end up giving the retiree too little to live on, the annuity industry offers a GMIB. Under this option, the participant must annuitize the benefit at retirement. Regardless of the cumulative impact of low interest rate trends or life expectancy data, a GMIB guarantees the retiree a minimum benefit. If investment performance of the underlying investment portfolio exceeds assumptions built into the original pricing model, the retiree can enjoy a higher benefit.
  3. Guaranteed minimum withdrawal benefit (GMWB). As implied by its name, a total amount that the retiree can take out has a fixed minimum based on total contributions. The formula guarantees income amounts subject to a specified withdrawal rate, such as 5%. With a GMWB, participants maintain control over the account.

Some in-plan products, such as “systematic withdrawal plans,” provide no guarantees. This option allows retired participants to determine the amount and frequency of their retirement income stream. Although not new, the model hasn’t been popular, according to the Institutional Retirement Income Council (“IRIC”), possibly because of its variability of long-term security, depending on the periodic withdrawal amounts chosen by retirees.

Is It Time for An In-plan Annuity?

One potential benefit of offering an in-plan annuity, according to the IRIC, is reducing retirement plan expenses. This option may slow the number of rollovers, leading to more plan assets which can give sponsors more leverage to negotiate favorable fee structures from plan service providers.

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