Morningstar Applies DOL’s Proposed Investment Selection Framework to Annuity-Embedded TDFs

As target-date funds with built-in annuities proliferate, plan sponsors are challenged to evaluate which products are the best fits for their participants, according to a new paper from Morningstar.

More than 12 target-date series now offer some form of guaranteed income in retirement, and assets within them grew 70% over one year—to $44 billion at the end of March 2026, up from $25 billion one year earlier, according to the paper, “Guaranteed Income in DC Plans: Evaluating Target-Date Funds with Built-In Annuities.” Broader multi-asset portfolios with in-plan annuities, including TDFs with annuities, surpassed $115 billion, an increase of 150% over two years.

BlackRock’s LifePath Paycheck offering is the largest. It held $26 billion in assets at the end of March, followed by AllianceBernstein’s custom target-date AB Lifetime Income strategy, with $14 billion at that time, according to the paper.

Meanwhile, with new entrants such as Vanguard—which manages roughly one-third of all target-date assets—and an explicit mention of lifetime income within the Department of Labor’s recently proposed rule outlining a fiduciary process for selecting investments in defined contribution plans, authors stated the trend is likely to continue.

Plan fiduciaries evaluating the prudence of their annuity-embedded TDF decisions should consider the six factors the DOL identified in its proposed rule, in addition to a few others, Morningstar’s report suggested. Aside from assessing benchmarking, complexity, fees, liquidity, performance and valuation, fiduciaries, when considering annuities, should also review factors such as insurer financial strength and the target-date manager’s process for selecting and monitoring the insurer.

Strength and Process

Morningstar’s paper made clear that the credit rating of the insurer backing an annuity “belongs in any serious analysis of the products.” While an investment-grade rating is not a guarantee of safety, selecting a highly rated carrier is a signal that the institution backing participants’ retirement income is financially sound. State guaranty associations provide a backstop if an insurer fails, but coverage limits vary by state and should not be relied on, the paper suggested.

Plan sponsors should also evaluate their target-date manager’s process for selecting and monitoring the insurer, the paper stated. Sponsors and investment consultants should not be expected to evaluate insurance companies themselves, but they can consider whether a manager uses a single carrier or multiple carriers, as well as whether the manager retains the ability to replace an insurer if the insurer’s financial condition deteriorates.

Benchmarking

“Benchmarking performance before retirement is relatively straightforward,” the paper stated.

Most target-date series with annuities have a sibling series built on the same glide path, asset allocation and underlying investments, according to Morningstar’s analysis. When the annuity is added to the fixed-income allocation of the TDF, the sibling series provides a “natural benchmark” because it is fully liquid, investable and shows how the strategy would have performed without the guaranteed income.

“If a meaningful performance gap emerges as participants approach retirement, it’s worth examining whether the annuity’s cost is creating more drag than expected,” the paper suggested. “Comparing both series against the broader target-date peer group adds more perspective by showing how the strategy stacks up against competing approaches, regardless of the annuity feature.”

Fees

The paper stated that while traditional investments’ fee trade-off is clear—“the less you pay, the more you keep”—evaluating fees for the annuity component of the TDF is more complicated.

Funds offering guaranteed lifetime withdrawal benefits have an explicit fee of about 1%, compared with a fee of 0.08% or less for more than half of share classes of traditional target-date assets.

“For funds using income annuities, costs are implicit and undisclosed, though they should be reflected in the income rates offered to participants,” the report stated.

The DOL’s proposed rule directs fiduciaries to weigh higher costs against the value the annuity provides. Across a diverse workforce, however, that could be a difficult judgment to make, given that some industries have longer life expectancies than others, the paper stated. A plan sponsor could, in turn, lean on its asset manager for analytical support, but that could raise a question of independence, since the sponsor is tasked with evaluating the manager.

Morningstar suggested that one approach for evaluating fees on income annuities is to compare the rates offered to plan participants against market rates for similar products. The potentially large scale of annuity-embedded TDFs could translate into better-than-average rates based on group pricing.

Complexity

“The idea [of guaranteed income] on paper sounds fantastic,” says Jason Kephart, a senior principal of multi-asset strategy ratings at Morningstar and one of the authors of the paper. “But I think once you get to funds offering this, the devil’s really in the details.”

The paper stated that while plan sponsors and their investment consultants may feel they understand how the TDFs with annuities work, participants may be left confused.

“A misunderstood product is a misused or unused product,” the report stated. “If participants disengage, the added complexity and potentially higher fees deliver little value at a higher price. Worse, participants who only partially understand these products may misuse them in ways that produce poor retirement outcomes.”

The paper suggested providers should offer plan sponsors plain-language disclosures, retirement income calculators and guidance to help participants understand what the products offer.

“Providers that can’t demonstrate these fundamentals should be crossed off the list,” the report stated.

Liquidity

At the participant level, a TDF remains fully liquid unless the participant elects to convert a portion of the balance into an income annuity, the paper explained. At that point, the assets that are annuitized become irrevocable, according to the paper. Products that incorporate annuities are able to preserve the annuities’ value when an employee terminates, though each product differs in how it does so.

Products that use a guaranteed lifetime income benefit structure avoid the liquidity trade-off entirely, however, by preserving full liquidity while providing a guaranteed income.

At the plan level, however, TDFs that incorporate stable value to support the lifetime income guarantee may require up to 12 months’ notice to unwind those investments, a function of the underlying stable value contract.

“Plan sponsors considering a provider change or menu restructuring should factor that runway into their timeline,” the paper stated. “That said, plan-level transitions rarely happen quickly, regardless, so for most sponsors, the notice period is a manageable constraint rather than a dealbreaker.”

Performance

When comparing target-date series’ performance, plan sponsors should not rely too heavily on capital market assumptions, the paper suggested.

“Small differences in assumptions about inflation, gross domestic product growth, or interest rates can lead to very different long-term projections, and no provider consistently gets it right,” the paper stated.

Morningstar’s paper instead suggested fiduciaries focus on whether the portfolio is broadly diversified among asset classes, geographies and risk factors. Instead of relying on a single prediction for the annuity component, plan sponsors should evaluate how guaranteed withdrawal or payout rates perform across a range of scenarios for interest-rate and stock market environments.

For guaranteed lifetime withdrawal benefits, plan sponsors can also examine how providers have adjusted rates over time to determine how stable and dependable guarantees have been.

Valuation

Morningstar stated that including an annuity in a TDF should not raise the kind of valuation concerns the proposed DOL framework is primarily addressing, as a TDF with an embedded annuity would still post daily net asset values at which participants can buy and sell shares of the TDF.

However, the paper stated, valuation takes on two approaches, both of which participants should evaluate. The daily net asset value reflects what a participant’s account is worth, while the GLWB structure serves as a benefit base that determines what a participant’s guaranteed income will be.

“For products that offer annuitization, the conversion rate that translates account value into monthly income is set by the insurer and can change, introducing a form of pricing uncertainty that sits outside the standard NAV framework,” the paper stated. “These aren’t reasons for concern so much as reminders that daily NAV, while necessary, doesn’t tell the whole valuation story.”