Annuities make target dates more complicated

BlackRock was ahead of its time in 2008 when the firm developed a target-date series and annuity pairing that didn’t take off.

It would be another 12 years before the company announced a new take on that idea, its LifePath Paycheck option for 401(k)s. And four years later, that product is set to launch, with the first retirement plan clients going live with it this month.

“I believe it will one day be the most used investment strategy in defined contribution plans,” BlackRock CEO Larry Fink wrote in his recent letter to clients, of annuity components of target-dates that give savers a clearer way to spend down their retirement assets. “We’re talking about a revolution in retirement. And while it may happen in the US first, eventually other countries will benefit from the innovation as well.”

With $27 billion in assets committed to it by a group of 14 plans representing half a million workers, BlackRock’s product would quickly become the largest target-date series on the market that includes an annuity component. Those assets would more or less double the size of the product category in the US.

To date, there are roughly a dozen such series that have either launched or are being developed, according to a report Tuesday by Morningstar. Following the SECURE Act that was passed in late 2019, companies started rolling out products, as the new law paved the way for more annuities within defined-contribution plans like 401(k)s.

Currently there are products available from Nuveen, State Street, American Funds, AllianceBernstein, Lincoln Financial, and Income America.

“The hard thing for a plan sponsor or consultant is that no two [series] are really the same,” said Jason Kephart, director of multi-asset ratings at Morningstar Manager Research. For example, the annuities offered within products differ, as some use income annuities and others include variable annuities, he noted.

But vetting products is only part of the difficulty involved in adding annuities to 401(k)s via target dates. One problem is educating plan participants about how to use the annuities features. That’s no small issue, given that the target-date market has essentially grown to its enormous level of $3.5 trillion with the help of inertia – plan participants are automatically enrolled in 401(k)s, and their contributions by default usually go to target-date funds.

While having an in-plan annuity can provide major help for people who might otherwise not choose a retirement income product, expecting them to know how to allocate assets to an annuity will require some work.

“The reason target-date funds have been so successful in helping people is that it's like an ‘easy button.’ It is: You just kind of set it and forget it,” Kephart said. “When you're at retirement, now you have to make decisions. That's where I think the education has to come in.”

Retirement plan record keeper Empower has offered an option, IncomeFlex, though that series no longer includes an annuity component as of the first quarter of this year, according to Morningstar.

“Empower found that 401(k) investors were not allocating enough to the target-date fund to generate enough guaranteed income to make the option worth opting into,” according to the report.

However, Empower hasn’t given up on the idea of annuities in target dates, as the company announced a series in March that includes American Funds and an income option from TIAA.

In the product category broadly, “we’re going to see a lot of evolution going forward – this is the beginning,” Kephart said.

Having annuities packaged within collective investment trusts is a key way to add them to target-date series – which is critical for making annuities part of a plan’s default investment option, said Tamiko Toland, owner of Toland Consulting.

“I love the idea of people being able to reach retirement and have the option of lifetime income,” Toland said. “One major challenge is how to help people understand how to use [it]… There is room for a lot of development in that area. I’m very optimistic about that, but it falls into the work-to-be-done category.”

Education for plan fiduciaries is also critical, as they must be clear on the type of annuity included in a target-date series and the kind of guarantee, if any, it includes, she said. Complicating that is that CITs don't necessarily include the types of information about their participants that is required for issuing annuities, she noted.

The percentage of target-date assets that get shifted into annuities, and when, is also a consideration, Kephart said. For example, the default used by BlackRock is 30 percent of assets at retirement being available to be annuitized, but people can increase that to 40 percent, he said. AllianceBernstein allows 50 percent, and plan sponsors may be able to allow as much as 80 percent for participants who want that much, he said.

But compared to the work people may be required to do to choose a retail annuity, the in-plan availability makes things simpler, he said.

“It's a big challenge for a lot of people to go out and shop for one and understand what they're doing,” he said. “Having something like a BlackRock or a TIAA do the vetting on the underlying annuity … that removes some of the friction.”