Representatives Donald Norcross (D-NJ) and Tim Walberg (R-MI) have introduced a bill in Congress to allow the default inclusion of annuities in 401(k) plans. If signed into law, it would functionally raise the profile of annuities, allowing individuals to hold large investments in this asset class based on the overall contributions to their 401(k) plans. Here’s what you should know about the bill and whether it’s an option to consider.
Consider working with a financial advisor as you plan out your retirement.
What the Bill Would Do
Currently entitled a bill “[t]o amend the Employee Retirement Income Security Act of 1974 to permit default investment arrangements in annuities, and for other purposes,” it is an updated version of a substantially similar bill from 2022 known as the Lifetime Income For Employees (LIFE) Act. If passed, it would allow employers to include annuities as a default investment option in employer-sponsored retirement plans such as 401(k)s.
Specifically, the bill would classify a certain type of annuity contract as a QDIA, or “qualified defined investment alternative.” In practical terms, this means that employer-sponsored retirement plans could automatically invest a participant’s money in a qualified annuity contract as well as more well-known assets like a stock portfolio. This would expand on steps already taken in last year’s SECURE 2.0 Act, which increased the overall footprint that annuities can have in a retirement portfolio by raising the cap on how much individuals can contribute to annuities with their tax-advantaged retirement accounts.
How This Bill Would Work
This bill limits plan contributions to 50%. This means that, if an employer does choose an annuity contract as their 401(k) plan’s default option, the plan can only invest up to half of a participant’s contributions in that contract. The rest must be invested in other assets such as stocks, bonds and funds. This is meant to ensure diversification in a participant’s portfolio.
Plan participants also must be allowed to opt out of the annuity contract within six months of being opted in, and the plan must explain their investment alternatives. This would apply both to new enrollees, such as a new hire, and to plan changes, such as if the employer restructures the company’s retirement plan in favor of annuities. In either case, each employee will have 180 days in which they can withdraw from the annuity without fees, penalties or any other charges. After that window, the plan can include delays and even surrender penalties if an employee chooses to withdraw from annuity investments.
This opt-out provision is where the updated LIFE Act particularly mirrors SECURE 2.0. That law allows employers to make retirement plan participation the default, giving employees the option to opt out of making contributions if they choose. That changed the current system, in which employees are left out of workplace retirement plans by default and must opt-in. Finance experts have found that opt-out systems increase participation substantially, as employees are much more likely to stay in a plan than they are to seek out participation.
The newly introduced bill would expand on that, allowing employers to automatically enroll their workers in a retirement plan that uses annuities as a default investment, with those participants then given the option to select another investment or stop contributing to the plan as a whole.
Pros and Cons The Bill
If this bill passes, individuals should make sure to carefully consider the potential benefits and drawbacks of annuity investments. The main benefit to annuity investments is its certainty. A standard lifetime annuity is an insurance policy that guarantees fixed payments, typically issued every month, starting in retirement and lasting for the rest of the participant’s life. As a result, it is not subject to the vagaries of market volatility, and it allows for confident financial planning. Participants know what they will receive, when they will receive it and for how long.
Annuities have their risks, though. In particular, they tend to post lower returns than the market at large, meaning that investors usually get a lower return on investment off an annuity contract than an S&P 500 index fund. They can also be fairly expensive, often charging high administrative fees. And, of course, there is always the edge-case risk that the company issuing the annuity contract might go out of business, forcing a risky question of who will hold up their end of the bargain in your retirement.
What’s more, despite its name, the updated LIFE Act does not require employers to select a lifetime annuity. Per the legislative text of the 2023 bill, the selected contract must make payments “for a fixed term or for the remainder of the life of the participant [and spouses or beneficiaries].” Retirement savers should review any plan carefully to make sure that the annuity their employer selects is a lifetime asset, or at least one with appropriate duration.
Annuities can be an excellent retirement vehicle, but make sure they meet your long term goals and needs.
Recently proposed legislation would allow employers to use annuity plans as a default investment in 401(k) and other employer-sponsored retirement accounts. The goal is to create a functional system of private pension accounts for workers. Whether it makes sense for you depends on the specific terms of your 401(k) and what your particular retirement needs are.
Retirement Planning Tips
- A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Are annuities the right investment for you? If your employer is going to start making this hybrid pension product the default choice in your 401(k), it might be time to learn all about how this investment class works and whether it’s a good fit for your plans.
Photo credit: ©iStock.com/shapecharge, ©iStock.com/tadamichi, ©iStock.com/FG Trade