The SECURE Act of 2019 passed with big changes to retirement income planning. It created a Fiduciary Safe Harbor Provision for employers which allows them to offer certain annuities inside 401(k) plans without worrying about their fiduciary liability if the insurance company defaulted on their annuity payments. While having access to annuities inside a 401(k) is not a new option, the passing of the SECURE Act will no doubt embolden plan sponsors to start including these retirement income options. The main question may no longer be IF they are available to you, but now is are they RIGHT for you?
Although having the additional option to purchase an annuity is a plus for improving employees’ retirement income options, annuities should be carefully considered because they are generally less liquid and more complex than the traditional fund offerings. Most annuities payments are only “pure life” meaning that the annuity payments will cease upon your death, leaving nothing to your heirs. The main benefit of annuities being that they will provide a guaranteed income stream throughout your lifetime.
Annuities can also be more complex in how they charge their fees or reduce your benefits. It is generally pretty easy to check on the fees that are being charged in your 401(k). You can simply ask your plan administrator for a list of expenses and fees that are being assessed to your plan and they will provide you with a detailed list. Annuities complicate this process because they contain their own early withdrawal penalties and annuity surrender fees. There can also be layers of other fees in the form of annuity riders that will provide additional benefits, such as a death benefit rider or “period certain” rider which would provide a spouse or heir with income after the retiree’s death. However, this will come at the cost of reducing your benefits over the life of the annuity.
The SECURE Act does not contain a requirement that employers provide the lowest cost or most efficient annuity options for your retirement plan. While ERISA does place certain obligations and fiduciary duties on plan sponsors, it should not be automatically assumed that they have selected the best annuity options for you. Annuities inside 401(k)s may pass the savings from having a large captive pool of potential investors and no longer needing to market these annuities to the purchasers. However, potential buyers should look always look at outside options that may be available to them in non-retirement accounts or in other qualified annuities after a 401(k) rollover.
Another issue with the annuities being available inside a tax-deferred account, like a 401(k), is you don’t pay taxes on the growth of an annuity until you take the money out. By already having this benefit inside a 401(k) and adding the same tax treatment benefit of an annuity does not provide you any additional benefit. It would be like wearing your raincoat while inside. In addition, while you can use your 401(k) balance to take out a loan, there is no loan option for the balance that is invested in an annuity. Therefore, you should consider using a taxable account when evaluating if an annuity in a 401(k) account is right for you.
While the idea behind having a guaranteed retirement income stream for life is very appealing, it should be very carefully considered and all options weighed before making the decision to contribute to an annuity inside your 401(k). When an annuity is purchased there can be costly surrender charges for reversing course, and once you start receiving payments your decision is often irrevocable. As always, consult a tax or investment professional before making these important decisions.