Annuities in 401(k) Plans

Risks and challenges in a rising interest rate environment Elizabeth Walsh


Massive shifts are taking place in the world of retirement planning, especially in the current rising interest rate environment. The Lifetime Income for Employees (LIFE) Act is a bipartisan bill built on the Setting Every Community Up for Retirement Enhancement (SECURE) Act designed to improve retirement savings opportunities. Under LIFE, annuities providing guaranteed lifetime income would be included as part of 401(k) and 403(b) plans as a default investment option for participants. If plan participants contribute to their retirement plans and have not allocated their investments, up to half of the default option would be an annuity that allows the retirement plan to resemble a traditional pension plan.

The plan uptake has been unpopular with participants despite employers and insurance companies working proactively to offer annuity and retirement income solutions. The annuity concept remains largely unfamiliar and seemingly complex to the plan participants, leading to a strong reluctance of handing over their retirement savings in one lump sum. Also, participants have limited knowledge about the various annuity options in plans, especially with diverse variability in product features with no limitations on the annuity provider with which plan sponsors can contract. Furthermore, although participants have up to six months to opt out of the annuity, taking contributions out of the annuity could incur high surrender charges depending on the terms of the annuity provider’s contract.

The slower-than-expected plan uptake could change in the current rising interest rate environment. Rising interest rates provide more flexibility to increase payout rates on living benefits, leading to increasingly competitive product offerings. If a portion of income is coming from fixed-income investments, higher yields would favor participants with annuity payments as one of their sources of income. Additionally, while fees for annuities are traditionally high (e.g., lifetime income annuities generally charge about 1%–1.5% of assets) due to the retail nature of the product, 401(k) plan annuities benefit from institutional pricing (e.g., regular target-date funds in plans charge about 0.10%–0.15% of assets).

As more 401(k) plans soon will include an annuity option, this is an emerging area of interest for actuaries. They need to translate market intelligence to design new annuity products with the 401(k) plan market in mind, along with performing static and dynamic profit testing. For example, annuities would vary based on whether they are fixed for the term of distribution or whether they consider account inflation or investment performance. Asset-liability management (ALM) strategies under a potential spike in interest rates—along with customized investment plans, prudent risk management framework and considerations for financial reporting implications—would need to be established.

Elizabeth Walsh, FSA, MAAA, is a consulting life actuary in New York and a contributing editor for The Actuary.

Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries or the respective authors’ employers.

Copyright © 2022 by the Society of Actuaries, Chicago, Illinois.