In-Plan DC Annuities and the Existential Plan Sponsor Question

Plan sponsors must consider life expectancy at retirement rather than what is projected at birth.

Plan sponsors will have to examine the purpose of their defined contribution retirement plan when they’re trying to decide if in-plan annuities are appropriate.

Does the employer-sponsored plan operate similarly to a defined benefit pension, as an income replacement vehicle for workers when they retire, or is it primarily for participants’ investment and accumulation only?

A TIAA white paper “Separating facts from perception: The valuable role that in-plan annuities can play in retirement SECURE-ity” aims to bust annuity myths. Misunderstanding annuities, in combination with the fact that many DC plans operate as investment-and-accumulation-only vehicles, have limited the products’ adoption in-plan. The research was co-authored by Phil Maffei, managing director for corporate retirement income products at TIAA, and Michelle Richter, executive director, Institutional Retirement Income Council and principal at Fiduciary Insurance Services.

“Annuities are really just the opposite of life insurance: Life insurance is going to protect you and your family members if you die too early, and annuities are going to protect you and your family if you live a healthy long life into retirement,” Maffei explains. “[Annuities] are [an] important tool in the financial wellness tool kit that every person should explore.”

Besides needing to change their view of what retirement plans are for, plan sponsors also should adjust their thinking about life expectancy, TIAA suggests. To understand the role in-plan annuities can play in providing for retirement income, employers must consider the person’s life expectancy at retirement. The overall life expectancy figure of 78.9, excepting any potential effect of COVID-19, “is meaningless,” according to the white paper.  

Per TIAA’s dividend mortality tables, single individuals have a near-50% chance at age 65 that they will live to 90 and about a 25% chance they will live to 95. For those with a same age spouse or partner there’s about a 45% chance that one member of the couple will live to 95, TIAA’s research found.

Myths Busted

Among the most persistent annuity myths is that the products are expensive, Maffei says. Plan sponsors can access annuities at institutional cost. The expense for participants in-plan is lower than the fees for similar products if purchased in the retail market.

“Yes, there are expensive annuities just like there are expensive cars, and you have to do your homework,” Maffei says. “If you went out to the open marketplace to buy health insurance, you’d probably pay more than if you got it through your employer’s plan.”

Another major myth that, according to Maffei, has limited the adoption of in-plan annuities, concerns the products’ portability. He says he has seen solutions that should help make annuities more portable for plans and individuals from so-called middleware companies.

“Maybe one thing that prevented employers from adopting these is ‘What if I adopt your annuity and then [the plan sponsor] move[s] to another recordkeeper,’” he says.

Companies that provide such solutions “allow a plan that uses an annuity product to move from one recordkeeper to the next more seamlessly,” he says, comparing this transaction to the ease of a plan sponsor switching recordkeepers but retaining access to the same mutual funds.

Annuities are “not to the point of open architecture yet; the ecosystem is developing,” he observes, noting they are only making an entrance to the 401(k) plan. “There’s a lot of opportunity there for additional pipes and plumbing and centralized hubs to be built,” he says. “Over the next three or four years, there’ll be a number of these middleware companies that will emerge.”

The Setting Every Community Up for Retirement Enhancement, or SECURE, Act, passed by Congress in 2019, has led to greater interest among DC plan sponsors in annuity products, he says.

“We’re seeing really a surge of interest from plan sponsors, consultants and other intermediaries, in understanding the space more,” Maffei says. “The SECURE Act, we think, is going to restart the interest in annuities, but this time inside a DC plan; you can effectively create what is like a defined benefit pension stream of income inside the defined contribution plan.”

Annuities don’t need to undergo fundamental changes for adoption to rise, he notes. Rather than alter the products, “the task is to [determine] how do we get the message across? It’s about understanding goals,” he says.

Despite annuities aiming to guard against longevity risk—i.e., DC plan participants outliving their savings—offering sequence of return risk protection and providing protection from the risk of cognitive decline in advanced ages, the broad, philosophical question remains: What is the retirement plan’s purpose? Employers learning to operate the plan as a lifetime income vehicle must ask this because offering in-plan annuities to participants could help address or mitigate each of the risks.  

“It’s a bit of a courtship when you’re trying to talk to a plan sponsor about making its plan more of a lifetime-income-focused plan, because most of these plans were designed for accumulation,” Maffei says. “It starts really with talking to the sponsor about what are its goals, what does it want its plan to be, and does it want it to be simply a tax-favored investment plan. Or does it want it to be an income replacement plan?”