Back in 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act allowed defined contribution retirement plans such as 401(k)s to offer annuities for the first time. These annuities had to provide guaranteed lifetime income, but other than that there were few restrictions.

In 2022, a bipartisan group in the U.S. House of Representatives introduced the Lifetime Income for Employees (LIFE) Act to take the idea further. The LIFE Act extends the SECURE Act’s “safe harbor” provisions that protect plan sponsors from annuity defaults. Though it hasn’t passed yet, it’s one of several measures aimed at building on the foundation of previous legislation to make annuities more compatible with 401(k) plans.

The idea is that with an annuity component, defined contribution plans will more closely resemble the once common defined benefit plan—i.e., pensions. More choices are usually better, but what exactly does it mean for your clients?

The Case For Annuity Inclusion
Jim Szostek, vice president and deputy of retirement security at the American Council of Life Insurers in Washington, D.C., says the inclusion of annuities in DC plans makes sense. “Annuities are the only product in the marketplace that can guarantee a lifetime income to supplement Social Security.”

Annuity provider Lincoln Financial also favors in-plan annuities. Ralph Ferraro, senior vice president and head of retirement plan services at the Radnor, Pa., firm, says that with annuities on board “employer-sponsored retirement plans can become more than an accumulation vehicle.”

That is, they can help with the “decumulation” that’s needed in retirement. “While accumulation is a well-understood concept and the objective of most plan options, the spending or decumulation part of the equation seems to be less clear to retirement savers, particularly as they try to project spending needs once their working years are behind them,” says Matthew Lemieux, senior vice president of product management at Jackson National Life Distributors in Nashville, Tenn. In-plan annuities provide a much-needed “level of income certainty that continues to be the No. 1 concern of those in or nearing retirement.”

Frank O’Connor, vice president of research at the Insured Retirement Institute in Washington, D.C., puts it this way: “The intent of a retirement plan is to provide retirement income”—which wasn’t happening when annuities weren’t involved.

Annuities can also provide other advantages not available in other 401(k) investment options, says O’Connor. Among them, he cites death benefits and downside protection in case markets fall.

The Case Against Annuities In Plans
While all this is no doubt true, it’s also undeniable that annuities aren’t right for everyone. “Income annuities likely won’t be the best recommendation [for] a typical retiree’s income strategy,” says Colleen Jaconetti, a senior manager at Vanguard’s Investment Advisory Research Center in Malvern, Pa.

Instead, she argues that a disciplined spending rate from a diversified investment portfolio provides greater flexibility and upside potential. “A low-cost annuity may be a viable complement to the investment portfolio,” she says, but it should never be “the primary instrument” for funding retirement income—or the only option plan sponsors offer.

What’s more, annuities “come with added fees, potential lower rates of return, and illiquidity risks,” says Spencer Betts, a financial planner and chief compliance officer at Bickling Financial Services in Lexington, Mass. Betts is also an ambassador of the Certified Financial Planner Board of Standards.

For some, those extra burdens can be too much. “Investors should proceed with caution and make sure the benefits outweigh the fees,” says Eric Bond, president of Bond Wealth Management in Long Beach, Calif.

Redundant Tax Advantages
Yet another key objection to placing annuities inside 401(k)s is that both are tax-advantaged instruments. Combining them provides no additional tax benefit.

“The tax deferral is redundant,” acknowledges Christopher Van Buren, a private wealth advisor at LVW Advisors in Pittsford, N.Y. “But the other benefits [of annuities]—such as guaranteed income—are very attractive.”

David Blanchett, Lexington, Ky.-based head of retirement research at PGIM, the investment management group of Prudential, concurs. “I just don’t think the tax advantaged nature of annuities is really the fundamental value proposition of the products,” he says.

“The reason for using an annuity,” says Eugene “E.J.” Long at Long Financial Group in Blue Bell, Pa., “is not the tax deferral but the proposed guarantee that the insurance company will pay a future income for life … plus spousal protection.”

Clients Want What Annuities Have
Studies show that annuities are wanted by many 401(k) holders. “Research from our Retirement Income Institute shows that close to half [of respondents] prefer a mix of protected lifetime income—annuities—and investments, and over 80% prefer a retirement plan that substitutes guaranteed income for bond investments,” says Cyrus Bamji, chief communications officer for the Washington, D.C.-based Alliance for Lifetime Income.

Besides guaranteeing lifetime income, in-plan annuities have another advantage. “The portability factor is important to savers,” says Chad Parks, founder and CEO of Ubiquity Retirement + Savings in San Francisco. “When an employee changes jobs, they can take the annuity with them.”

Can Plan Sponsors Handle Annuities?
Yet some remain concerned about suitability. “Annuities are way too complex for plan sponsors to properly vet and understand,” says Karl Wagner III, a partner and senior wealth advisor at Biondo Investment Advisors in Sparta, N.J.

On the other hand, suitability may depend on the employer. To some extent, the degree of complexity comes from “how the products are ultimately offered and positioned to participants relative to other plan options,” says Lemieux at Jackson National. Plan sponsors, he says, should invest “in education and planning tools.”

That may be easier for some than others. “Large plan sponsors probably have the resources and personnel … to navigate the annuity landscape. My fear is for the small plan sponsor,” says M. Tyler Ozanne, a principal at Probity Advisors in Dallas. “Many of these plan sponsors barely have enough time and energy to properly maintain the administrative requirements for their plans, let alone the investment options. Add to those responsibilities the need to understand the vast annuity landscape, and I am afraid these plans might be exposed to the wolves of annuity salesmen.”

Simplifying Annuity Options
Ozanne would like to limit the types of annuities allowed in defined contribution plans to only the most basic types.

“It’s important to discern the difference between an immediate annuity [which provides] a stream of guaranteed income from a lump sum, usually with low cost, and a deferred annuity [which is] usually high cost, high commission and has terrible returns,” says Steven Podnos, a certified financial planner at Wealth Care in Cocoa Beach, Fla. He fears sales reps will push the latter just to earn commissions.

But Cathy Marasco, assistant vice president of product development at Nationwide Retirement Solutions in Columbus, Ohio, doesn’t quite agree. “As with any new solution in our industry, there is a period where plan sponsors need to ramp up their understanding. That’s what’s happening right now,” she says.

Moreover, annuity providers insist the products are more user-friendly than ever. “This new breed of in-plan annuities is flexible and easy to administer,” says Matt Gray, assistant vice president for worksite and middle markets at Allianz Life in Minneapolis, Minn.

Legal Protections
Part of what the SECURE Act did was establish a fiduciary “safe harbor” for plan sponsors when they choose annuity products. “Plan sponsors must follow guidelines and rules to qualify for the safe harbor,” explains Rick Tasker, a managing director and principal at Robertson Stephens in Santa Rosa, Calif. To that end, the plan sponsor has to file annual benefit statements and fee disclosures, as well as allow members to transfer their annuities to an IRA or other retirement plan if the sponsor phases out the option.

“The existing regulatory framework effectively protects consumers against potential problems or conflicts,” says Jason Berkowitz, chief legal and regulatory affairs officer at the Insured Retirement Institute. He notes, however, that his organization welcomes opportunities to discuss and address any problems that do arise.

Still, some wish the rules required partnering with a certified financial planner. “The average investor will need to understand the pros, the cons and the features,” says Grace Yung, a CFP Board ambassador and managing director at Midtown Financial Group in Houston.

Jason Branning of Branning Wealth Management in Ridgeland, Miss., goes a step further. “The insurance companies that offer annuities in 401(k)s should have a fiduciary mandate that is consultative,” he says, “rather than servicing the plan sponsors with a commission-based sales team.”

An Optimistic Outlook
Looking forward, the outlook seems optimistic. Allowing annuities in 401(k)s “opens the door for carriers to innovate and tailor product designs for this market,” says Paula Nelson, head of strategic growth for individual markets at Global Atlantic Financial Group in New York City.

Blanchett at PGIM agrees. Expanding the annuities market “could allow for the introduction of a series of high quality, low-cost products that haven’t been introduced in the retail space yet,” he says. “Overall, I see this as definitely a potential win for consumers.”