Vetting annuities for 401(k)s not an easy task

Retirement plan sponsors have long been uneasy about adding annuities to their 401(k)s, and new research shows that evaluating some products might be more difficult than previously thought.

While it is easy to choose annuity providers based on price and payout rates, those costs and rates can change frequently, so the options that are best today might not be as good in several years. That's according to an analysis from David Blanchett, Morningstar Investment Management’s head of retirement, Michael Finke, a professor of wealth management at the American College of Financial Services and Branislav Nikolic, vice president of research at Cannex Financial Exchanges.

“It complicates things to some extent. When you select an insurance company or an annuity in a 401(k) plan, it’s not like selecting a large growth fund. You’re making a long-term commitment,” Blanchett said. “The relative competitive position of companies can change dramatically over time. That’s not necessarily problematic if you have access to a window of providers — but if you only have one … the odds of that company being the best three or five years from now are not very good.”

The research examined weekly life-only annuity payout rates from 30 insurers from Nov. 3, 2013, to Aug. 12, 2020, for different age groups and households — male, female and joint.

The average cost of choosing a single annuity provider was 4% during the timeframe, although the cost was more than 9% for some insurers and as high as 12% for certain ages and household types, the authors noted. That range indicates that plan sponsors “must evaluate multiple annuity providers over time rather than simply selecting the lowest cost provider today,” the paper states. “If a plan relies on a ‘shelf’ of annuity products, each provider should be re-evaluated and highly-rated insurers that have consistently competitive quotes over time may be more attractive.”

Further, some of the companies examined during the period shifted from having attractive payout rates to comparably low ones over short amounts of time, the authors noted.

Notably, the paper did not include data for guaranteed lifetime withdrawal benefits, the optional living-benefits riders sold alongside annuities. Those products, which have a presence in some defined-contribution plans, do not change prices as rates as frequently as deferred income annuities and single-premium immediate annuities, Blanchett noted.

“But if you think about other products that are more like SPIAs and DIAs, I have a bit more pause, just because there’s no guarantee that the relative competitiveness of that product will remain constant over time,” he said.

Because of that, 401(k) plans opting for those particular guaranteed-income products might want to choose more than one provider. And even then, evaluating providers frequently would be wise, Blanchett said.

Under the 2019 Secure Act, plan sponsors got a fiduciary “safe harbor,” affording them some protection from liability if they go through the necessary steps of properly vetting insurers and annuities.

A recent report from the Center for Retirement Research at Boston College found expected returns for annuities on average have changed little over the past 25 years. That paper examined the “money’s worth” a 65-year-old would get from immediate annuities, fixed annuities and deferred annuities with payouts beginning at 85.

“The main finding is one of surprising stability, with the expected return on immediate annuities remaining similar to estimates from 25 years ago, at around 80 cents per dollar of premium,” the authors of that report wrote. Deferred annuities had an average expected return of about 50 cents per dollar of premium during that time, but they also had considerably higher insurance value than immediate annuities, according to the report.