Does an annuity belong to a 401(k)?

When 401(k) plans began replacing private employer pension plans decades ago, employees lost a crucial part of their retirement plan: a guaranteed income stream for life. Unlike pensions, 401(k)s place the risk of outliving the savings on the shoulders of the retiree.

As part of the Every Community Establishment for Retirement Enhancement Act, Congress has encouraged 401(k) plans to offer annuities. “An annuity is insurance for your lifetime income, much like your own personal pension,” says Philip Maffei II, managing director of TIAA’s corporate retirement income products.

If you’re nearing retirement and want an annuity, buying one through a 401(k) has advantages, but variety isn’t one of them. Most 401(k)s only offer an immediate fixed annuity, which begins paying income immediately for the rest of your life. If you want another type, such as a variable annuity with market exposure for potentially higher growth or a deferred annuity, you’ll likely need to purchase it outside of the plan. Here’s what else you should consider.

The bulk of the work has been done

Employers have been reluctant to include annuities in 401(k), fearing liability in the rare event an annuity company fails. The SECURE Act protects plan sponsors from liability provided they follow federal guidelines for selecting viable insurers. For example, an employer must consider credit rating, financial health, and costs related to employee benefits. Companies must have met state requirements, including maintaining sufficient reserves, for the past seven years. These protections also help employees. “You have a sophisticated expert looking at products first,” says Sri Reddy, senior vice president of retirement income at Principal Financial Group.

Group price may be a better deal

While the plan doesn’t have to go with the cheapest provider, “generally, large group pricing leads to a better deal than individual markets,” says Maffei. For women, there is an added benefit. “Annuities in a 401(k) should use unisex pricing,” says Wade Pfau, professor of retirement income at the American College of Financial Services. In the individual market, companies may charge different rates based on gender. “It’s good for women inside the plan because they tend to live longer. It’s not as good for men, relatively speaking, who may find a better option outside the plan,” explains Phew.

You can keep your pension even if your employer does not

In the past, if your employer changed annuity providers, you might have to change as well, losing your existing benefits and your guaranteed income stream. Now, when the employer changes providers, you can keep the annuity and “transfer it to an IRA to preserve your benefits at no additional cost,” says Reddy.

You will have a better idea of ​​your income

Whether or not they offer annuities, plan sponsors are required to estimate the guaranteed lifetime income your account balance could potentially generate if you purchased an annuity, which helps you determine if it’s worth it. sadness. You should get a life estimate and a joint life estimate if you are married.

You may be able to transfer funds

One obstacle to buying an annuity in a 401(k) is that your retirement savings can be scattered across different accounts. “Most employees move pockets of savings into an IRA when they change jobs,” says Reddy. “They might not have enough in their current 401(k) to properly fund an annuity.” Some companies may allow employees to transfer other retirement funds into the 401(k) using a rollover, but retired employees will not have this option, even if they still have money in the 401(k). k).

The clock is ticking if you have doubts

Unless the plan offers something other than an immediate annuity, you’re locked in once you buy it, although Reddy says you’ll have at least a 30-day free research period during which you can withdraw from the contract. “Once you start receiving lifetime income payments, you can’t change your mind,” says Maffei.

Income is fully taxed

Because you used pre-tax dollars to purchase the 401(k) annuity, 100% of that income will be taxable. When you buy an annuity outside the plan using after-tax dollars, a portion of your payments are tax-free because the company refunds your initial contribution.