Annuity vs. 401k: How both can work for you
The Annuity Man
With over 10,000 baby boomers reaching retirement age every single day, retirement worries are front and center for many Americans looking to live their golden years with dignity and also having the needed income guarantees in place.
Current 401k annuity legislation (aka: The Secure Retirement Act) is a long term plan that will hopefully transition retirement plan participants from a current market growth focus to lifetime income guarantees once they decide to retire.
As we all know, Social Security was never put in place to be the primary retirement income source, so our friends in DC are now legislating personal finance type options that now encourage retirement plan sponsors to offer their employees annuity strategies for future pension type income. In my opinion, that's a good thing.
Accumulation to Income
As you get closer to retirement, or even in retirement, most people start transitioning from accumulation (i.e. growth) to income with at least a portion of their portfolio. Everyone's specific needs are different, but different sources of guaranteed income makes sense for current income goals and future inflation expenses.
Defined Contribution Plans (aka: 401 k plan type) are in place for workers to have a retirement plan where their assets will grow tax deferred, typically using mutual funds to achieve those market growth goals. Most of these employer sponsored plans currently have no choices for future lifetime income. That is going to drastically change with the new Secure Retirement Act that was signed into law in December of 2019.
In the past, your only choice was to “roll” (i.e. transfer) your 401k assets to an IRA and then shop for the best lifetime income annuity. You can still do that, but now most 401k type plans will offer annuities that guarantee a lifetime income stream when you retire.
Instead of plan participants worrying about things like surrender charges, early withdrawal penalties, or mutual fund choices...our friends in Washington now want workers to start thinking about converting or allocating a portion of that 401k type plan into a personal pension.
Shouldering Risk to Transferring Risk
When you invest your money into pure stock market type growth strategies, you are shouldering that risk of the money potentially losing value. When you are young, that is an acceptable choice because you have time to “make it back” from most temporary market downturns. As you start thinking about or getting closer to retirement, you then need to start transferring that risk instead of shouldering it. If lifetime income is the goal, you will be transferring that risk to an annuity carrier (i.e. life insurance company) to provide a lifetime income stream to combine with your Social Security annuity type payment.
Combining those payment guarantees is what I call the “income flooring.” The income floor is the money that hits your bank account every month regardless of what happens in the world. It’s contractual, and going to happen for as long as you live.
Every day I receive questions like “Should I convert my 401k to an annuity?” or “Should I buy an annuity with my 40lk?” The answer is only if you need a lifetime income guarantee. That’s the best example of how 401ks and annuities can work together, because annuities are the only product that can contractually guarantee a lifetime income payment.
However, if you don’t need additional income, then you should just transfer (aka: roll) those 401k assets to an IRA and manage that money or have someone do that for you. By the way, that 401k to IRA transfer is a non-taxable event.
Demographic Tidal Wave
Those previously mentioned 10,000 baby boomers and people already in retirement primarily care about a couple of things, making sure they never run out of money or just protecting what they have. Every working American can already rely on their Social Security Benefits and those lifetime payments, but most need more income to live the lifestyle they desire and have worked hard to earn.
People need to plan for their income choices sooner than later. If they are in a 401k type structure that offers a future lifetime income product, that should be a part of their annual contribution limit and overall allocation strategy. If they are already retired or want to roll their 401k dollar amount to a lifetime income stream strategy, they need to know the type of annuity that will provide the highest contractual guarantee and shop all carriers for the best deal available. There's not one "best" annuity carrier or one "best" annuity product. The best annuity choice is to find the highest contractual guarantee for your specific situation and goals.
Even though too many agents try to sell a variable annuity or indexed annuity regardless of the client’s stated goals, the best lifetime income strategies are fixed annuity types like Single Premium Immediate Annuities (SPIAs), Deferred Income Annuities (DIAs), and Qualified Longevity Annuity Contracts (QLACs). These are all simple and easy to understand transfer of risk lifetime income strategies with no annual fees and no moving parts. Remember that lifetime income guarantees are primarily based on your life expectancy at the time you take the payment. Interest rates play a secondary role.
It’s also important to find an agent or advisor who has access to an annuity calculator that quotes all annuity carriers. Remember that annuities are commodities, and quotes change every 7 to 10 days like a gallon of milk. In order to lock in a desired quote, you need to be moving forward with the application process.
Passing The Retirement Ball
So is an annuity good for retirement? Our “leaders” in DC seems to think so by offering the best inflation annuity on the planet (i.e. Social Security), and now encouraging employer sponsored plans (i.e. 401k's) to offer annuity lifetime income choices. That doesn’t mean you need an annuity, but if lifetime income is the goal, annuities are your only choice.
Annuities are the only product on the planet that guarantees an income stream regardless of how long you live. It’s a monopoly that only annuities can offer. That’s a fact that most people are not aware of, and that messaging blame falls squarely on the annuity industry’s shoulders. I also think annuities being offered within 401k type retirement plans is a good combination of strategies, and great for the consumer.
The majority of retirement plans/retirement savings should be focused on retirement income with at least a part of everyone’s portfolio. The annuity vs. 401k question is not an either or, but instead needs to be how they can work together. Growth and income are important and both should play an important role for working Americans and their retirement plans and goals.