When 401(k)s began to replace private employer pension Decades ago, employees lost a crucial part of their retirement plan: a guaranteed income stream for life. Unlike pensions, 401(k) plans place the risk of outliving savings squarely on the retiree’s shoulders.
As part of the Setting Every Community Up for the Retirement Enhancement ActCongress encouraged 401(k) plans to offer annuities. “An annuity is insurance for your lifetime income, kind of like your own personal pensionsays Philip Maffei II, TIAA managing director of corporate retirement income products.
If you’re close to retirement and want an annuity, buying one through a 401(k) has advantages, but variety isn’t one of them. Most 401(k)s offer only an immediate fixed annuity, which begins paying income immediately for the rest of your life. If you want another type, like a variable annuity with exposure to the market for potentially higher growth or deferred annuity, you may need to purchase it outside of the plan. This is what you should consider.
The heavy lifting has been done
Employers have been reluctant to include annuities in 401(k) plans, fearing liability in the rare cases an annuity company fails. The SECURE Act protects liability plan sponsors as long as they follow federal guidelines for selecting viable insurers. For example, an employer must consider the annuity company’s credit rating, financial health, and rates related to benefits paid to employees. Businesses must have met state requirements, including maintaining sufficient reserves, for the past seven years. Those protections also help employees. “First you have a sophisticated expert reviewing the products,” says Sri Reddy, senior vice president of retirement income at Principal Financial Group.
Group price may be a better deal
Although the plan isn’t required to go with the cheapest provider, “in general, large group pricing leads to a better deal than individual markets,” says Maffei. For women, there is an additional advantage. “Annuities in a 401(k) should use unisex pricing,” says Wade Pfau, professor of retirement income at The American College of Financial Services. In the individual market, companies may charge different rates based on gender. “This is good for women on the plan, as they tend to live longer. It’s not so good for men, relatively speaking, who may find a better option outside the plan,” says Pfau.
You can keep your annuity even if your employer doesn’t
In the past, if your employer changed annuity providers, you may have had to switch too, losing your existing benefits and guaranteed income stream. Now, when the employer changes carriers, you can keep the annuity and “roll it over to an IRA to keep your benefits without incremental fees,” Reddy says.
You will have a better idea of ​​your income
Whether they offer annuities or not, plan sponsors should estimate how much guaranteed lifetime income your account balance could generate if you were to purchase an annuity, which will help you determine if it’s worth it. You should get an estimate for your life and a joint life estimate if you are married.
You may be able to transfer funds
One hurdle to buying an annuity in a 401(k) is that your retirement savings may be spread out among different accounts. “Most employees move pockets of savings into an IRA when they change jobs,” says Reddy. “They may not have enough in their current 401(k) to adequately fund an annuity.” Some companies may allow employees to transfer other retirement funds to the 401(k) via rollover, but retired employees won’t have this option, even if they still have money in the 401(k).
The clock is ticking if you have doubts
Unless the plan offers more than just an immediate annuity, you’re locked in once you buy it, though Reddy says you’ll have at least a 30-day free trial period during which you can opt out. “Once you start receiving income payments for life, you can’t change your mind,” says Maffei.
Income is taxed in full
Because you used pre-tax dollars to purchase the 401(k) annuity, 100% of that income will be taxable. When you buy an out-of-plan annuity using after-tax dollars, part of your payments are tax-free since the company returns your original contribution to you.