Many Americans look with longing at old-fashioned pension plans, which cover a dwindling share of the workforce.
After all, aside from providing a guaranteed monthly paycheck for life, pensions spare retirees the hassle and anxiety of figuring out how to make their nest eggs last.
Now the retirement paycheck is staging a comeback—inside the 401(k).
As baby boomers retire and withdraw their nest eggs, 401(k) plans are losing assets. Employers are adding income-producing investments and services to plans in part to persuade older workers—who tend to have the largest balances—to keep their money in the 401(k) rather than move it to an individual retirement account.
One-third of plan sponsors now offer retirement-income investments or calculators, up from 11% in 2018, according to investment-consulting firm Callan LLC. The trend is likely to get a boost from a law that went into effect on Jan. 1 that makes it easier for 401(k) plans to offer annuities, insurance contracts that convert savings into lifelong payments, similar to a paycheck.
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The trend is positive for retirees who want a somewhat predictable income and are unsure how to make their money last. But these new products come with some downsides.
Here is how to assess whether the new products are right for you.
ANNUITIES
Advisers say annuities can make sense for retirees unable to cover their basic living expenses with guaranteed sources of income, including Social Security.
While few 401(k) plans offer annuities, some financial-services companies are adding them to target-date funds, popular default investments for employees who are automatically enrolled.
Vanguard Group and Fidelity Investments, the two largest providers of target-date mutual funds, say they have no immediate plans to incorporate annuities into those products. But firms including Prudential Retirement already have such options and BlackRock Inc., JPMorgan Chase & Co. and State Street Corp. say they are developing them.
Before buying, it is important to understand an annuity’s fees and features, including when payments start, their size and whether you can get your money back. Variable annuities typically provide some exposure to the stock market and allow buyers access to their money. Fixed annuities often feature higher payout rates but no stock market exposure and may require buyers to surrender principal to the insurer.
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To see how variable annuities work, consider the one United Technologies Corp. offers in its 401(k) plan. The company defaults employees into a target-date fund with a variable annuity that invests in stocks and bonds and guarantees retirees an annual income for life.
Guaranteed income builds up after age 48 and can rise if the account balance increases but won’t decline, said Robin Diamonte, chief investment officer. The cost, including investment fees, is about 1.18% a year, versus over 2% in the individual market, according to Morningstar Inc.
Employees can cash out the portfolio’s value—before or after starting withdrawals—without fees, said Ms. Diamonte. When the owner dies, beneficiaries inherit the account’s value.
BlackRock is developing a target-date fund with a fixed annuity.
Economists have called the task of figuring out how to spend a nest egg in retirement “the nastiest problem in finance, yet in the U.S., we have said to everybody, ‘Go figure it out on your own,’” said BlackRock Managing Director Anne Ackerley.
State Street Global Advisors is designing a target-date offering for clients, including a large public university, that will allocate up to 25% of retirees’ assets to a deferred annuity that starts payments at age 80.
A married retiree who opts to buy the deferred annuity will receive about 15% of the purchase price annually, from age 80, for as long as both spouses live, said David Ireland, global head of defined contribution. The annuity includes a death benefit and a 2% inflation adjustment. Knowing this safety net will fall into place, retirees may be able to withdraw a higher percentage of their other savings earlier in retirement than they would otherwise.
State Street expects to charge about 0.15% annually, versus about 0.09% for a target-date fund without an annuity, Mr. Ireland said.
MANAGED PAYOUT FUNDS
Annuities got a lot of attention when Congress recently passed legislation making it easier for employers to offer them in 401(k) plans. But employers are also adding other types of income-producing investments. These lack income guarantees but allow investors to withdraw their money at any time.
Fidelity offers managed payout funds for a fee that ranges from 0.25% to 0.28% a year for the cheapest share class. Starting this spring, retirees can elect to take an annual income that currently starts at 4.05% of the balance for a 60-year-old and rises to 17.15% for a 93-year-old.
Related
- Congress Passes Sweeping Overhaul of Retirement System (Dec. 19, 2019)
- Income Options Are Coming to 401(k) Plans (July 11, 2019)
- The Deal Hidden in Your 401(k) (June 10, 2019)
- Forget the 401(k). Let’s Invent a New Retirement Plan. (Feb. 10, 2019)
JP Morgan, T. Rowe Price Group Inc. and Capital Group’s American Funds have similar offerings.
If stocks decline, these funds may reduce their payout rates, or increase their allocations to stocks to take advantage of cheaper valuations.
MANAGED ACCOUNTS
For people with more-complex financial lives, for example, those with multiple investment accounts or competing savings goals, a managed account can deliver more-customized investment and withdrawal advice that encompasses assets outside the 401(k). Available in about one-quarter of 401(k) plans, managed accounts pair portfolios devised by algorithms with human advisers, often for about 0.4% annually.
A growing number also offer the option of a monthly paycheck in retirement.
Edelman Financial Engines LLC’s Income+, available in about 350 401(k) plans, moves about 80% of an average retiree’s 401(k) balance into bonds to generate a predictable payout, currently from 3.7% to 5% depending on factors including age. The other 20% goes into stocks to give the portfolio growth potential.
Later this year, the company plans to provide participants with greater flexibility to take slightly higher payouts or allocate more to stocks, said Christopher Jones, chief investment officer.
Write to Anne Tergesen at anne.tergesen@wsj.com
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