Do annuities have a place in 401(k)s? Traditionally, they have been offered only as a way to cash out when retiring. Even then just 1 to 6 percent of participants choose them. Now a handful of plan providers are trying to sell annuities to employers for a different purpose -- as a way for employees to build up a guaranteed retirement income while they are still working. The idea is to replicate the guaranteed income of a defined benefit plan.
A cluster of firms are either devising or have recently launched annuity-type products. They include Genworth Financial, an insurance company spun off from General Electric Co.'s financial services arm; Metropolitan Life Insurance Co., in partnership with Merrill Lynch & Co.; Prudential Financial; and Retirement Engineering, a new Boston-based firm.
“We’ve got an environment where there are lots of accumulated 401(k) balances, but not a lot of knowledge on the part of participants about how to turn those balances into lifetime income,” explains Scott Sleyster, executive vice president of full-service retirement at Prudential’s retirement services subsidiary.
Advocates acknowledge that these products can mean higher fees and less liquidity, but they say risk-averse clients will be willing to pay for the security of a guaranteed income. They argue that one way to earn sufficient income is to start building an annuity before retiring.
The products share a basic structure. When making a 401(k) contribution to the annuity-type product, a participant “buys” a specific amount of monthly postretirement income. Essentially, participants are purchasing a minifixed annuity with every contribution. The contribution-income formula is recalculated regularly, based on current interest rates and the participant’s age and life expectancy. In Retirement Engineering’s version, for instance, a one-time $67 contribution would provide $1 in monthly lifetime income for a 47-year-old woman after she retired at 65, or about $230 in total over her expected life span of 84 years.
In addition to offering a guaranteed income stream, the products avoid what David Wray, president of the Profit Sharing/401(k) Council of America, a trade association, calls “interest rate roulette.” Purchasers of standard fixed annuities normally get stuck with the interest rate on the day they buy a standard fixed annuity. But these new products recalculate the contribution-income formula with each contribution. “It will smooth out over time,” Wray says. “Some years interest rates will be high, some low.”
Merrill has signed up 15 clients with plan assets of $5 million to $60 million apiece; it hopes for an additional ten by year-end. Genworth expects to sign its first plan sponsors before the end of the year, and Prudential is aiming to launch next year.
They’ve got a tough sell ahead. For a start, they charge an extra fee for the income guarantee, typically about 75 basis points. “If the vendors are going to book something out for 40 years, they’re going to make sure they’re protecting themselves,” notes Richard Koski, a managing director at New York Citybased Buck Consultants. “How much is that price differential going to affect the participant’s opportunity for greater returns?”
Vanguard Group decided not to offer the products because it determined that the costs to participants would be too high, says Robert Nestor, principal for retiree services. Instead, Vanguard is hoping to persuade more people to convert some portion of their 401(k)s into annuities when they retire.
