What is a 401k Annuity?
The Annuity Man
Is there such a thing as a 401k annuity? Up until December of 2019, that answer would have been a flat out NO. However, with the signing of The Secure Act, 401 k plans and similar retirement plan types will now be able to offer annuity lifetime income strategies to plan participants. That’s good news for workers needing to plan for retirement.
So now there is actually a product that we can call a 401k annuity. Is it a good thing? As with all annuity questions, there’s no perfect answers...just bad sales pitches. It’s always a good idea to tell the truth because you don’t have to remember anything. That’s certainly the case when it comes to annuities. Let’s take a look at the facts of this new 401k annuity animal.
What is a 401K?
A 401k is a tax advantage plan where employee contributions are typically enhanced by an employer contribution as well. There are contribution limits to 401 k accounts, and most plan investment choices are mutual funds. The goal as a 401k participant is to grow your money tax deferred while you are working. When you retire, you transfer those 401k assets to a personal IRA and continue to make your own investment choices.
Now retirement plans are able to offer annuity lifetime income strategies, so it’s important for you to understand the different types and how they contractually work.
What is an Annuity?
An annuity isn’t just one product. So much for that ridiculous “I Hate Annuities” mantra. There are many types of annuities available. Fixed annuities for lifetime income are Single Premium Immediate Annuities (SPIAs), Deferred Income Annuities (DIAs), and Qualified Longevity Annuity Contracts (QLACs). Income riders attached to some deferred annuities (like a Variable Annuity or Indexed Annuity) also provide lifetime income guarantees.
Regardless of the type of annuity, it is issued by a life insurance company. If you decide to buy an annuity, that decision should be solely based on the contractual guarantees of the policy. If lifetime income is the goal, it’s important to know that the annuity payments are primarily based on your life expectancy (life expectancies, if joint) at the time you start the income stream. Interest rates play a secondary role.
Some annuities have surrender charges with a deferred contract, and some types are “annuitized” irrevocable income stream contracts. There’s not a one size fits all, even though many agents will mistakenly pitch Fixed Index Annuities (FIAs) as that perfect strategy. Spoiler alert, there is no perfect annuity product.
The annuity types that will fall under the “401k Annuity” banner will most likely be Single Premium Immediate Annuities (SPIAs) and Deferred Income Annuities (DIAs). Both are the same simplistic structure, and have no annual fees and no moving parts.
If I was appointed “Annuity Czar” (which I should be!), those would be my pro-consumer choices.
In 2014, our friends at the IRS and the Treasury Department developed and introduced a Qualified Longevity Annuity Contract (QLAC). The primary intent of this annuity was to be included inside of 401k type plans for future income needs. Great idea, but with poor execution. Not many plan sponsors were willing to take on this annuity type because of litigation concerns and overall lack of annuity education. So I guess you could call the QLAC the first 401k annuity, albeit a failed attempt. By the way, a QLAC is actually a Deferred Income Annuity (DIA) structure….if you are keeping score.
Qualified Longevity Annuity Contracts (QLACs) are gaining in popularity because they can also be used in Traditional IRAs (Individual Retirement Accounts) as future income guarantees while potentially lowering income taxes on your RMD (Required Minimum Distributions). Baby boomers love QLACs because it allows you to use your personal IRA to set up a joint lifetime income guarantee with your spouse.
Those failed QLAC implementation lessons were learned, so The Secure Act included a provision that held the plan sponsors “harmless” when it comes to fiduciary requirements. In other words, they couldn’t be sued for including only a few annuity carriers as choices for plan participants.
That provision alone will drive the growth of this new “401k Annuity” type.
Structural Peanut Butter with Contractual Jelly
So now you know why there is a picture of a peanut butter and jelly sandwich at the top of this article. Let’s cut to the chase, the peanut butter is the 401k plan structure and the new contractual lifetime income annuity choice is the jelly. They now go together.
So when people ask, “Is an Annuity better than a 401k?”...you are kind of talking about the same thing. Annuities are now part of the choices that plans offer. Your future 401 k investment account balance and allocations will be a combination of mutual funds and annuities for future lifetime income.
This new 401k annuity legislation (i.e. The Secure Act) that allows companies to offer annuities is a game changer for retirement income planning. That’s an understatement, and also a gentle reminder from our friends in D.C. that Social Security was never designed to be your primary income source.
Your Future Income Floor Matters
Setting up your “Income Floor” is an important part of most people’s retirement plan. Your income floor includes your Social Security payments, RMDs (Required Minimum Distributions) from your IRA, pension payments (if so lucky), and now maybe a 401k annuity if you plan offers one. Income Floor payments are the guaranteed income streams that will hit your bank account or retirement savings account every month regardless of what happens in the world.
Purchasing an annuity is like buying a plane ticket. You shop all carriers for the highest contractual guarantee for your specific situation. Annuity quotes are like a gallon of milk and expire every 7 to 10 days unless you lock them in during the application process. It’s important to find an objective annuity calculator or 401k annuity calculator to find the highest contractual number.
So whether it’s a 401k annuity or a Retirement Annuity outside of an employer plan, lifetime income guarantees are very important to most Americans nearing or at retirement. That’s a demographic tidal wave of lifetime income needs that can’t be denied.