A growing number of employers are exploring ways to help 401(k) participants turn their savings into a sustainable income in retirement, even ahead of Congress passing legislation that would make it easier to do so.
“For many savers, the ultimate outcome they desire is income to replace their paychecks,” said Mark Iwry, a Brookings Institution fellow and a former Treasury Department official who oversaw retirement policy during the Clinton and Obama administrations.
These new income-producing offerings are mainly geared toward employees over 45, who are likely to have a better sense than younger workers of whether these products suit their needs, given factors including their health, savings and projected Social Security benefits.
Social Security as of this year only replaces 41% of the average career earnings of workers in an income bracket making an average of $51,894 annually. For earners making an average of $128,400, the replacement rate is 27%, according to the Social Security Administration.
In May, the House passed a retirement bill that would encourage 401(k) plans to offer annuities, which are insurance contracts that guarantee a monthly income for as long as a retiree lives. The legislation is currently stalled in the Senate, but is still widely expected to pass. Mr. Iwry says the current efforts could “help restore pension to the private pension system.”
Advisers say annuities can make sense for retirees unable to cover their basic living expenses with guaranteed sources of income, including Social Security.
“We expect to see a continual gradual ramp-up in both annuities and other lifetime income options within 401(k) plans,” said Winfield Evens, director of investment solutions and strategy at 401(k) record-keeper Alight Solutions LLC.
United Technologies Corp., maker of Otis Elevators and Pratt & Whitney airplane engines, is one company that already offers an annuity option in its 401(k) plan.
Since 2012, two years after closing its traditional pension plan to new employees, UTC’s offering is a default option for all its 401(k) participants and starts out as a low-cost, target-date fund for younger employees. Between ages 48 and 60, the portfolio shifts to an annuity, while still investing in equities and bonds.
The fund is designed to offer the best attributes of 401(k) and traditional pension plans, says Robin Diamonte, chief investment officer at United Technologies. “It’s really important that our employees are not spending their energy worrying about finances for retirement,” she said. “They can focus on work.”
The investment cost for the converted annuity fund is roughly 1.2%, far less than nearly 4% individuals typically pay for similar annuity products. The plan guarantees retirees an income of about 5% of the account balance, measured on the account owner’s birthday each year. Employees can cash out anytime with no special fees other than those required for all 401(k) savers under current tax law.
The offering has proven popular among UTC’s 90,000 U.S.-based employees. Roughly 45,000 workers in its $27.6-billion 401(k) plan have all or some money invested in its Lifetime Income Strategy fund, which has $1.8 billion in assets.
To diversify the potential risk, UTC uses three insurance companies — Prudential Financial Inc., Nationwide and Lincoln Financial — to provide guarantees for the annuity. The insurance companies are overseen by state regulators, and if one becomes insolvent, policyholders’ assets are protected by a guaranty fund of the state in which they reside. That limit is typically $250,000 per person, but can be as high as $500,000 in some states including Connecticut.
Industry watchers predicted other companies would follow. But today, only about $5 billion to $6 billion of the $5.7 trillion in 401(k) plans are in annuities, according to insurance-industry research organization, Limra Secure Retirement Institute.
For annuities to gain substantial momentum in 401(k) plans, they will have to find a way into target-date funds. So far, Vanguard Group and Fidelity Investments, the two largest providers of target-date funds, say they have no immediate plans to include annuities in these funds.
Other companies, including BlackRock Inc. and State Street Corp. are developing target-date funds that either include an annuity or give investors the option at a certain age to transfer some of their savings into an annuity. BlackRock said it may launch its product later this year.
If the legislation becomes law, insurance companies are expected to step up marketing for lifetime-income products for corporate retirement plans.
“There will be more participants and more interest in this over time,” said Phil Waldeck, president of Prudential’s Prudential Retirement unit, which offers a target-date fund with annuities. “There will be a marketplace like there are for target-date funds and other solutions.”
Employers are also adding other income-producing options to 401(k) plans. In contrast to annuities, the income isn’t guaranteed.
Managed accounts are available in 32% of 401(k) plans, according to Vanguard. For about 0.40% in fees, they pair algorithm-driven portfolios with human advisers. Many offer the option of a regular monthly paycheck.
For example, Edelman Financial Engines LLC’s Income+ moves about 80% of an average retiree’s 401(k) balance into bonds, which generate a predictable income stream. The other 20% goes into stocks to give the portfolio the potential for growth, an allocation that gradually shifts to bonds as the account owner ages.
T. Rowe Price Group Inc. recently introduced a managed payout fund that gives retirees in its target-date fund the option to receive 5% a year of their average account balance over the previous five years for no additional cost.
Later this year, Fidelity plans to launch managed payout funds that 401(k) plans can offer retirees ages 60 or older for a fee that starts at 0.25% a year. Retirees can elect, for no additional cost, to take an annual income that starts at 3.6% of the balance for a 60-year-old and rises to 8.7% for people 84 or older.