Annuities Are Readily Available In 401(k)s But Are They Right For You?

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The SECURE Act of 2019 passed with major changes to the retirement income plan. This created a fiduciary safe harbor provision for employers that allows them to offer certain annuities within 401(k) plans without worrying about their fiduciary liability if the insurance company defaults on their annuity payments. While access to annuities inside a 401(k) is not a new option, the passage of the SAFE Act will undoubtedly encourage plan sponsors to include these retirement income options. The main question may not be whether they are available to you, but are they right for you now?

Although the additional option of purchasing 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 traditional fund offerings. Most annuity payments are “net life” only, meaning that the annuity payments will cease upon your death, leaving nothing for your heirs. The main advantage of annuities is that they will provide a guaranteed income stream throughout your lifetime.

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Annuities can also be more complicated in how they charge their fees or reduce your benefits. It’s usually pretty easy to check up on what’s being charged into your 401(k). You can simply ask your plan administrator for a list of the expenses and charges that are being assessed for your plan and they will provide you with a detailed list. Annuities complicate this process because they include their own early withdrawal penalty and annuity surrender fee. There may also be layers of other charges in the form of annuity riders that will provide additional benefits, such as a death benefit rider or a “fixed term” rider that will provide a spouse or heir with income after the death of the retiree. However, this will come at the cost of reducing your benefits over the life of the annuity.

The SECURE Act does not require that employers provide the lowest cost or most efficient annuity option for your retirement plan. While ERISA places certain obligations and fiduciary duties on plan sponsors, it should not automatically be assumed that they have selected the best annuity option for you. Annuities inside a 401(k) can pass the savings on to a large captive pool of potential investors and are no longer required to market these annuities to buyers. However, potential buyers should always look at external options that may be available to them in non-retirement accounts or in other qualified annuities after a 401(k) rollover.

Another issue with annuities available inside a tax-deferred account, such as a 401(k), is that you don’t pay taxes on the growth of an annuity until you withdraw the money. You don’t get any additional benefits by already putting this benefit inside a 401(k) and adding the same tax treatment benefit as an annuity. It would be like wearing your raincoat while inside. In addition, while you can use your 401(k) balance to take out loans, there is no loan option for the balance invested in the annuity. Therefore, you should consider using a taxable account when evaluating whether an annuity in a 401(k) account is right for you.

While the idea behind having a guaranteed retirement income stream for life is appealing, it should be considered very carefully and all options weighed before deciding to contribute to the annuity inside your 401(k). The reverse course can result in costly surrender fees when an annuity is purchased, and once you start receiving payments your decision is often irreversible. As always, consult a tax or investment professional before making these important decisions.

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