SELECTION CONSIDERATIONS FOR PLAN SPONSORS WHEN INCLUDING AN ANNUITY IN A DEFINED CONTRIBUTION PLAN
By David Blanchett
Defined contribution (DC) plan sponsors are increasingly focused on getting participants not just “to” but also “through” retirement. For example, the percentage of plan sponsors seeking to retain retiree assets in the DC plan has increased from 46% in 2015 to 74% in 2021, and while 17% of plan sponsors preferred to move retiree assets out of the DC plan in 2015 only 7% did so in 2021 (DCIIA 2022).
However, the strategies and solutions required to help participants accumulate a sufficient balance to get “to” retirement can be very different than those that help participants deplete savings to get “through” retirement. One approach to account for these differences is allocate savings to a product or solution that provides some form of guaranteed, or protected, lifetime income, such as an annuity. While most 403(b) plans offer some type of annuity today, less than 20% of 401(k) plans do.1
This paper provides context around key considerations for plan sponsors who are deciding whether to include an annuity in a DC plan and provides general guidance on which approach to select given plan sponsor preferences and other relevant criteria. Five annuity product-types are reviewed: single premium immediate annuities (SPIAs), deferred income annuities (DIAs), a fixed annuity (FA) with a guaranteed lifetime withdrawal benefit (GLWB), a variable annuity (VA) with a guaranteed lifetime withdrawal benefit (GLWB), and protected lifetime income benefit (PLIB) strategies, in addition to delayed claiming of Social Security benefits.
Research on optimal annuities has primarily focused on the economic benefits of the various solutions and has generally ignored product and behavioral
considerations. The definition of the most “efficient” annuity for a DC plan can change considerably, though, when a more comprehensive perspective is taken. For example, while DIAs (or Qualified Longevity Annuity Contracts, or QLACs, assuming certain provisions are met) are often touted among retirement academics as being the “optimal” annuity given their explicit hedge against longevity risk, but this perspective doesn’t consider notable behavioral and product drawbacks affecting their economic efficiency.
Overall, this research suggests there likely isn’t a single annuity product structure that is going to work for all DC plans given the notable differences in product features and likely varied preferences among plan sponsors and participants. Therefore, it is essential that DC plan sponsors interested in longevity solutions continue to stay abreast of developments in future as the space continues to evolve, especially since the DC annuity ecosystem is in its infancy.
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David Blanchett, PhD, CFA, CFP®, is Managing Director and Head of Retirement Research, DC Solutions for PGIM, the global investment management business of Prudential Financial, Inc. In this role he develops research and innovative solutions to help improve retirement outcomes for investors. He is also an Adjunct Professor of Wealth Management at The American College of Financial Services.