Adding guaranteed annuity options inside of defined contribution plans is gaining momentum, according to a report from Financial Research Corp., Boston.

These are “in-plan” products that participants can understand and that will create guaranteed income sources, says Luis Fleites, FRC vice president and director of retirement markets research and author of the report.

Group variable annuities and traditional fixed annuities have already been offered as options in a small percentage of defined contribution plans, he points out. But those annuity products are not leveraged for annuitization, he says.

“They are being used primarily for accumulation within the DC plans,” Fleites says. “So, when employees leave the plan, they typically roll the money into an IRA or take lump sum distribution.”

What’s new is that product manufacturers have begun designing DC annuity options specifically for the purpose of providing retirement income. Fleites terms these “income annuities” or “guaranteed annuity options.”

The report, “Guaranteed Annuities in Defined Contribution Plans: Current Products and Future Prospects,” explores 4 such options (see chart) and mentions others.

“In-plan” products offering guaranteed retirement income will likely emerge as an asset class in their own right, predicts Fleites. Paving the way are firms that are already working to make retirement income a part of asset allocation strategy, he observes.

Record keepers–which run and administer DC plans–are already voicing “significant interest” in the trend and some are currently conducting due diligence on these products, says Fleites. In fact, an FRC survey conducted in May 2007 found that 78% of record keepers believe annuities designed for DC plans should be part of their solution set, and 67% said they are now improving or developing these types of products. (See table)

Large corporate plans will likely be early adopters, too, perhaps followed by investment and actuarial consultants who work with the large plans, according to Fleites.

Will advisors distribute these products, as well? Yes, advisors will play a significant role in bringing the products to the small and mid-size 401(k) plans, he says, adding that the small/middle market represents a significant chunk of the defined contribution market, “so there should be definite growth opportunities here.”

But first, traction needs to develop among the larger players, which he says have the necessary size and sophistication to foster momentum. Their adoption of the products will help build greater awareness and understanding, he says.

“Also, advisors will need time to learn about these income products, their appeal and benefits,” he says.

Some advisors will need to overcome their own resistance to the products, Fleites adds. Using income annuities and annuity-like products inside a 401(k) represents a change from traditional asset allocation, he explains, and “well-entrenched advisors will need to consider whether they want to change, in order to offer these products.”

In addition, some advisors may see less value in providing the products, he continues.

In time, advisors will probably want to make the change, Fleites says. As their boomer clients reach the older ages, many will have greater interest in products that “do the job (of income distribution) better,” he says. The old “laddered portfolio” approach is too labor intensive.

In the report, Fleites notes that several factors are spurring this trend along. One is a safe harbor rule in the Pension Protection Act of 2006 that’s expected to take effect early in 2008. It requires clarification that the “safest available annuity” standard does not apply to annuities in defined contribution plans.

Other factors, according to the report, include:

–The need of retiring baby boomers to create a guaranteed income stream.

–The volatility in the equities markets.

–The ongoing decline in defined benefit pensions.

–Continuing questions about Social Security’s future.

But the report also notes that several hurdles are impeding widespread acceptance of these in-plan annuity options. For instance, some recordkeepers are unfamiliar with the products, don’t see demand and/or have apprehension about establishing long-term relationships.

In response, manufacturers will have to amend the negative perception of annuities through education programs, says Fleites. Participants will need to be made aware that they are purchasing an income option, he continues.

“The goal is not only to promote adoption but to be certain that participants fully understand what they are buying and what they can expect upon retirement,” he says.

Manufacturers will also need to overcome fiduciary concerns with benchmarks and guarantees, improve portability at the participant and recordkeeping levels, and develop consistent pricing structures, he says.