Clients today want more from their retirement savings accounts—more in the way of flexibility and control with respect to investment options, but also more assurances against the possibility of outliving their retirement savings. For clients who do not have the means to purchase guaranteed income with funds outside of tax-deferred investment accounts, investing a portion of a traditional 401(k) in a fixed indexed annuity (FIA) with a guaranteed lifetime income rider can provide this certainty without sacrificing the client’s ability to allocate 401(k) funds between more traditional investments.
While the basic in-plan annuity option has been on the table for some time, the available options are now much more specifically tailored to client demands, so we are likely to see the trend continue to gain traction. However, it is important that this trend be balanced against the need to advise clients on how to maximize tax-deferral potential, which, for wealthier clients, may make the in-plan annuity strategy inappropriate.
How the 401(k)-FIA Option Works
Typically, the annuity products that have been offered within 401(k) plans were immediate annuities that limited access to the client’s 401(k) funds, an option that many clients rejected because they wanted access to the account value in case of emergency.
Today, the FIA with guaranteed income rider can provide similar benefits with more flexibility. Once the client makes the election to hold the annuity within the 401(k), he can either allocate a lump sum toward the annuity or specify a portion of each contribution that will be invested in the annuity—effectively allowing the client to purchase the in-plan annuity over time.
The lifetime income rider, as the name suggests, guarantees that your client will receive a certain level of income—based on age and the investment—for life once the rider is “turned on” and the client begins receiving payouts. Further, the client often has the option of turning the income stream on or off once income payments begin.
Importantly, the FIA with guaranteed income rider is portable, meaning that when the client leaves the employer, his annuity can leave with him as an IRA in the same manner as any other 401(k) asset. While the plan sponsor will likely be named owner of the annuity (and any other 401(k) assets) while the client still works for the employer, the client becomes the owner when he leaves. This portability allows the client to move the annuity without restarting the surrender period.
The FIA with guaranteed income rider allows clients to access the cash value if necessary, though it is important for clients to know that possible surrender charges should make this a last resort. Therefore, while the potential for accessing the cash in the annuity in case of emergency may appeal to many clients, this very feature could defeat the purpose of the planning strategy.
Not all employers that offer 401(k) options currently provide the FIA with a guaranteed income rider option because of the administrative modifications that are necessary in order to offer the choice. While the option may become more common as the market for in-plan annuities grows, many employers may currently be unwilling to adopt the administrative processes necessary to offer them because of additional costs or may simply pass along the extra costs to employees, making the option less attractive.
Some clients may find that it makes less sense to hold FIAs within their 401(k) accounts because, while the FIA allows funds to grow on a tax-deferred basis, so does any 401(k) account—regardless of the client’s investment choices. As such, many might argue that using the in-plan annuity strategy provides little additional benefit, as the funds will grow tax-deferred whether the annuity is held within the 401(k) or outside the plan.
In fact, for wealthier clients, this raises a suitability issue; clients who have sufficient savings outside of tax-deferred retirement vehicles to purchase separate, independently tax-deferred products to guarantee retirement income should be advised that the in-plan strategy is not best suited to maximizing tax-deferred savings. Because there is an annual limit on the level of funds that can be contributed to a tax-deferred 401(k) each year, some clients would be best advised to maintain an annuity outside the plan in order to maximize the annual tax-deferred investments.
Purchasing the annuity with pre-tax dollars, however, can be attractive to clients who are nearing retirement age because it may allow them to allocate more to the product, thereby increasing their guaranteed income and simplifying their planning by consolidating investment vehicles. Younger clients, on the other hand, may find that allocating funds toward the guarantee can limit their ability to invest in more aggressive investments that might be more appropriate for their risk tolerance level.
For clients looking to both guarantee retirement income and simplify planning by managing the annuity product under a single umbrella vehicle, the FIA with guaranteed income rider may provide an appealing solution, especially as more employer-sponsored 401(k) plans move toward offering the option in the future.