Annuities can help you create additional income for retirement outside of what you expect to get from your 401(k) or a similar tax-advantaged account. Thanks to the passage of the SECURE Act, adding annuities to your employer-sponsored retirement account is now a possibility. But does an annuity in a a 401(k) make sense for your financial situation? It’s an important question to ask as you save and invest for retirement. Here’s what you need to know about incorporating an annuity option into your workplace savings plan.
What Is the SECURE Act and What Does It Do?
The Setting Every Community Up for Retirement Enhancement (SECURE) Act passed in December 2019 and it represents a major change to how employers approach workplace retirement plans. The new law took effect Jan. 1, 2020, and directly affects retirement savers in a number of ways, including:
- Increasing the age at which required minimum distributions must begin to age 72
- Removing the age cutoff restriction for making contributions to traditional IRAs
- Making part-time employees 401(k) eligible
- Allowing for penalty-free 401(k) and IRA withdrawals for the birth or adoption of a child
- Expanding 401(k) auto-enrollment benefits
- Offering tax incentives for small businesses to offer retirement plans to employees
- Making it easier for grad students and foster parents to save for retirement
- Allowing employers to offer annuities as part of their 401(k) plans
401(k) Annuity Rules Under the SECURE Act
That last provision is designed to make purchasing annuities easier for savers who want to include them as part of their retirement plan. An annuity is an insurance contract that you buy from a broker or insurance company. You pay either a single premium upfront or a series of premium payments toward the annuity. Then at a specified date, the company you purchased the annuity from pays you, either in a lump sum or as a series of payments.
Annuities can be difficult to understand and to purchase if you don’t know much about them. For example, annuities aren’t one-size-fits-all. You can have a deferred annuity, which begins paying money to you at a future date or an immediate annuity, which begins paying money to you typically within one year of purchasing it.
Annuities can also be fixed, variable or indexed, based on how the premiums you pay are invested. An indexed annuity, for example, may be invested in index funds or other mutual funds that are designed to mimic the performance of a specific stock market benchmark, such as the Nasdaq Composite or the S&P 500. A fixed annuity, on the other hand, earns a fixed rate of return and is generally a low-risk way to accumulate money for retirement. There are even fixed indexed annuities, as well.
The SECURE Act could help remove some of the confusion surrounding annuities by leaving it up to 401(k) plan administrators to decide which annuity products to include. If a plan offers a simple income annuity, for example, you could choose to purchase it to generate guaranteed lifetime income once you retire, alongside any money you’re withdrawing from your 401(k), IRA or taxable investment accounts, as well as the money you’re getting from Social Security.
Pros of a 401(k) Annuity
The SECURE Act opens up the door to investing in an annuity through your workplace retirement plan and there are some potentially good reasons to consider it.
For one thing, you may benefit from lower pricing by purchasing a 401(k) annuity. If plan administrators are able to secure institutional pricing for annuities inside the plan, that could translate to lower costs for you to own one. Paying less in fees is a good thing since fewer fees means you get to keep more of your money’s growth.
Annuities that are sold directly to consumers can have a number of fees, including mortality risk fees, commissions paid to the broker selling the annuity, surrender charges and early withdrawal fees. And of course, the underlying investments in the annuity will have their own fees. For example, if your annuity holds mutual funds, each fund would have an expense ratio.
Holding an annuity inside your 401(k) can also offer a measure of assurance about your retirement future if you haven’t contributed as much to the plan as you’d like or you got a late start on saving. Broadly speaking, annuities are designed to provide lifetime income and under the SECURE Act, plan administrators are required to choose annuities that guarantee income for life.
That means you’ll receive payments from the annuity until you pass away, with the potential to extend those benefits to your spouse or another beneficiary. If your nest egg is smaller than you’d planned or you’re unsure how much money you’ll receive from Social Security, an annuity could help you feel more confident about having enough income to retire.
Cons of a 401(k) Annuity
On the other hand, the SECURE Act doesn’t require plan administrators to choose the lowest-cost annuity option. That means it’s possible that investing in a 401(k) annuity could be just as expensive as purchasing one on your own. What’s also important to keep in mind is the reliability of the annuity company that a plan administrator chooses.
The SECURE Act imposes a fiduciary standard on plan administrators when it comes to choosing an annuity provider. That means plan administrators have to act in the best interests of plan contributors when choosing a company that offers simple lifetime income annuities. The wording of the act, however, essentially allows for the annuity provider to self-verify their financial status and stability. So it’s possible that even with the act in place, you could end up purchasing an annuity from a company that may run into financial trouble down the line, leaving them unable to make your annuity payments.
Finally, it’s important to consider whether a 401(k) annuity is a good choice for the long term if you think you’ll change employers at some point. Having an annuity inside your plan may affect your decision-making when it comes to deciding whether to roll over your plan to an IRA if you change jobs or transfer it to your new employer’s 401(k).
The Bottom Line
Before passage of the SECURE Act annuities and 401(k)s were distinct, but the new law makes it possible to purchase annuities inside your employer-sponsored plan. Nevertheless, it’s important to do your homework first to make sure such a combination complements your retirement strategy.
- Consider talking to a financial advisor about holding an annuity inside your 401(k). Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
- Get to know the basics of annuities and the different types. Take time to learn the types of fees you can expect with an annuity and how much annuities can pay out. The better you understand how they work and what they can do for you in retirement, the easier it becomes to decide whether purchasing one is the right move.
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