The Future for Annuities in DC Plans

The SECURE Act offered an annuity selection safe harbor for plan sponsors, but education will be the first step in getting this income protection to plan participants.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act was passed in an effort to build retirement income and prevent retirees from outliving their savings. Now, even as defined contribution (DC) plan sponsors have a safe harbor for selecting annuity products to offer participants, what does the future for this guaranteed income look like?

When it comes to the near-term, don’t expect leaps toward annuity products, say retirement planning experts. Instead, employers will want to encourage education and communication surrounding annuity products, rather than actual implementation. Plan sponsors and participants tend to misunderstand annuity products as too expensive or too high risk, so adding educational opportunities can be enough to open interest.

“Our near-term expectations for 2020 and early 2021 will be a lot of education with retirement planning committees, with implementation following that later in 2021,” states Kerry Bandow, senior consultant for Russell Investments in Seattle. “It will be a gradual implementation. I don’t think we’re expecting to see a rush to the door, as committees are looking at the need for education and making participants aware.”

Melissa Kahn, the managing director for Retirement Policy at State Street Global Advisors in Washington, D.C., believes a focus on annuity products will not only grow attention among participants, but among plan sponsors too. Because of new safe harbor provisions in the SECURE Act, as long as employers follow all safe harbor steps—including obtaining receipts of written representations—they will have satisfied their fiduciary duties under the Employee Retirement Income Security Act (ERISA).

“For many plan sponsors, especially those that don’t engage with outside consultants, it’s been overwhelming for them,” Kahn says.

Still, on the plan participant level, more education is needed to understand the value behind annuity products. Participants generally have an aversion to annuities, so if plan sponsors mention them, participants are less likely to adopt because they’re hesitant to spend a portion of retirement savings to buy the product. Rather than an annuity, plan sponsors may see interest with lifetime guarantee features, such as a target-date fund (TDF) with an annuity component or a qualified longevity annuity contract (QLAC).

Bandow says, “We’ll probably see more immediate take-up in those products that have an embedded guarantee.”

Warming up to annuity products is really the first step to incorporating the addition, experts agree. Once participants see the amount of lifetime income their accumulated savings could buy, they’ll begin to ask questions, notes Thomas Roberts, principal at Groom Law Group in Washington, D.C. However, because the Department of Labor (DOL) has up to one year to issue interim final rules for the SECURE Act’s lifetime income disclosure requirement,Roberts does not foresee much curiosity until then.

“The illustrations will drive the demand for lifetime income, and pick up will come down the road, once participants begin to familiarize themselves with those concepts,” he observes.

Unlike with in-plan annuity products, Roberts doesn’t anticipate a big jump toward out-of-plan options. The latter is only accessible via a rollover, he says, so the model is unlikely to take off.

With more education and better knowledge, safe harbor annuity products have a strong chance of being adopted. Having routine and frequent conversations with DC plan committees and adding the topic of lifetime income to committee meeting agendas increases awareness, says Holly Verdeyen, head of Institutional Defined Contribution at Russell Investments in Chicago. Once participants see monthly income streams that they could expect in retirement, plan sponsors will want to evaluate how they can help their employees understand how they can realize what they see on their statements.

“They will start to think not just about the products, but all the different ways they can help their employees actualize lifetime income into the plan,” she mentions. “It’s more about tools and communication, and the way they’re talking to their employees about what they’ve invested and how they can translate that in the future.”

Kahn likens this point to the passage of the Pension Protection Act (PPA) and implementation of TDFs. When the measure was first introduced, participation rates among TDFs were low. Now, at 14 years after the enactment, TDFs are one of the most widely used investment products in the industry. It’s taken time for the plan sponsor community to understand and embrace these options, therefore a similar path is likely to occur for annuity features as well, she says.

“It will be an educational effort,” Kahn adds. “The next three to five years will see a lot of innovation, educational opportunities and, hopefully, take-up.”