Vanguard put a team of its experts to work on answering one of the major retirement planning questions of the day: Will adding an annuity, or an annuity-like feature, to a target-date fund inside a 401(k) plan really help workers get a modern alternative to the old defined benefit pension plan, or will it just create all kinds of complicated new financial riddles?
The team's answer: It depends.
"The value offered to a participant depends on the design of the hybrid annuity TDF and is influenced by factors like timing and amount of the income funding strategy, annuity type, and share of the income funding strategy used to buy the annuity," the team wrote in a paper that describes their findings.
But the plan sponsors and plan participants would still need personalized advice to know whether a "hybrid annuity TDF" was right for their own situation, according to Vanguard.
"Most hybrid annuity TDFs involve a decision to annuitize, and many participants are not actively engaged or informed enough to make an appropriate decision about when to purchase an annuity and how much to annuitize," the paper states.
What it means: For workers who have no interest in retirement planning, a major new hybrid annuity TDF effort could be just another confusing part of the financial fog swirling around them.
For financial professionals, a major hybrid annuity-TDF push could create three separate forces:
- Resistance to individual advice from prospective clients who prefer to stick with both the employer's default asset-accumulation and income-generation options.
- New opportunities to advise participants in hybrid annuity-TDF plans, in cooperation with the plan sponsors and administrators.
- New opportunities to advise participants who would be better off if they broke free from the employer's default asset-accumulation and income options.
The history: Many U.S. employers once promised workers guaranteed retirement income for life through defined benefit pension plans.
The plans were complicated and expensive to administer, but employers and their advisors handled all funding and investment decisions.
Falling interest rates and tough new federal employer responsibility rules pushed employers away from the defined benefit plan strategy.
Today, the typical employer with retirement benefits makes no promises about income and simply provides access to a menu of mutual funds and other investment options through a 401(k) plan, 403(b) plan or similar participant-allocated plan.
The Pension Protection Act of 2006 created "qualified default investment alternatives," or QDIAs, that protect the plan participants from having to allocate their own investments while they are accumulating assets.
Choosing the QDIA, or simply letting cash flow into the QDIA without making any conscious choice, is a way for workers to turn responsibility for asset allocation over to institutional money managers.
The income problem: Many economists, financial planners and others have argued that converting a nest egg into a guaranteed stream of lifetime income can be as complicated as allocating the assets during the nest egg accumulation phase.
Some have argued that adding some kind of built-in annuity or annuitization option to a retirement plan is to the income stage of retirement what providing a QDIA is for the accumulation phase.
Advocates for combining target-date funds with in-plan annuitization options, or what Vanguard calls the "hybrid annuity TDF," contend that, for most workers, who have no real interest in actively managing their nest eggs, offering QDIA users default income options is an obvious path to follow.
BlackRock CEO Larry Fink has predicted that the annuity-TDF combination will soon be the most commonly used investment strategy at defined contribution retirement plans.
The Vanguard thinking: Here are five questions on the Vanguard experts' minds, drawn from the new paper.
1. What kinds of annuities or annuitization options will be used?
