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Monday, September 20, 2010

Some 401(k) Plans Are Adding an Annuity Option

NYTimes.com
By FRAN HAWTHORNE
Published: September 15, 2010
BURDENED with a reputation for being inflexible and expensive, annuities have never been popular in retirement plans. But insurance companies and Wall Street investment firms have produced a new crop of products that fiddle with the standard structure.
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Minh Uong/The New York Times
Their idea is that these products can promise employees the security of a traditional pension, while freeing employers from the task of paying for it. However, they are still having trouble breaking through the A-barrier.
Hewitt Associates LogoImage via WikipediaOnly 2 percent of 401(k) plans include some sort of annuity or insurance option as an investment choice alongside standard stock and bond funds, according to Hewitt Associates, a benefits consulting firm in Lincolnshire, Ill. An additional 3 percent are “very likely” and 17 percent are “somewhat likely” to add the category this year, Hewitt says.
Promoters hope that hearings this week, sponsored by the Treasury and Labor Departments, will lead to federal regulations that clarify some of the administrative concerns.
“Most people would want, as they approach age 50, to have some sense of what level of income they would have at retirement,” said Thomas J. Fontaine, global head of defined contributions at the investment management firm AllianceBernstein, one of more than a half-dozen insurance companies and money managers devising these products. “And they will want to know that they will have that income for life.”
The products work in two basic ways. The most common varieties are tied to target-date funds — premixed funds that base their investment strategy on the date the employee hopes to retire, automatically changing the mix as the date draws nearer.
In the AllianceBernstein model, an increasing portion of the target-date assets are shifted to a special guaranteed fund starting at age 50, with 100 percent in that fund by five years before the retirement date. Although the product isn’t complete, Mr. Fontaine said he expected it to guarantee a 5 percent rate of return for life, for a fee of about 1 percent of the assets.
Prudential Retirement has a product that combines a group variable annuity with a target-date fund, basically insuring against market downturns, also for a 1 percent fee. It guarantees that each year for the first 20 years of retirement, an investor can withdraw an amount equal to 5 percent of the assets that were in the target-date fund at its highest year, even if the market crashed the year before retirement. After 20 years, Prudential starts paying that 5 percent.
The MetLife Building (formerly the Pan Am Buil...Image via WikipediaMetLife’s Personal Pension Builder takes a wholly different approach, akin to a deferred fixed annuity. Each time someone makes a 401(k) contribution, all or part of the money essentially buys a mini-annuity (also known as a laddered annuity), getting the prevailing interest rate at that time. Thus, a person who contributed every two weeks would be purchasing 26 mini-annuities that year.
What all these products have in common is that employees use their 401(k) assets to buy a guaranteed, steady payout for the rest of their lives after they retire. The cost is usually around 1 percent of the assets guaranteed, on top of the regular 401(k) fees.
For many people, the added security is worth the price.
“We insure everything — disability, our car, our house — but we don’t insure the risk that we could outlive our assets,” said Pamela Hess, Hewitt’s director of retirement research. She recommended that people use this kind of guarantee for around half of their 401(k) assets.
There are other concerns, however. Because so many parts are movable — including the interest rate, the retirement date and the amount of the contribution — companies worry about the administrative difficulties. It is not as simple as having one small-company stock fund for the whole work force.
Like a standard annuity, some of the new products depend on a single insurance company’s staying in business long enough to keep paying out the guarantees, maybe for decades.
“How do you fix this if it’s not the right provider?” Ms. Hess asked.
Jody Strakosch, MetLife’s director of retirement products in the United States, has a ready reply for that sort of criticism: “MetLife has been meeting our financial obligations for 140 years.”
And John Kalamarides, the senior vice president of retirement strategies and solutions at Prudential, said new “safe harbor” rules from Washington could relieve some employers’ fiduciary concerns in selecting insurance companies.
On the plus side, the target-date-related products are more flexible than annuities. Investors can pull out their money at any time, although that means they will have paid the extra fee for nothing.
The firms pitching these products say demand is growing. In a survey of 1,300 companies last fall, MetLife found that 44 percent of employees “would like my employer to offer an annuity option” in their 401(k) or similar retirement plan. A MetLife spokeswoman acknowledged that the statement could refer to rolling over the 401(k) into an annuity at retirement, as well as having an investment option.
Stephen P. Utkus, who runs the Center for Retirement Research at the Vanguard Group — which does not sell any of these new products — said that trying to buy security with a 401(k) investment was a mistake. The best approach, he says, is simply to build a bigger nest egg.
“Our clients view having a portfolio of assets itself as a form of security,” he said.
A version of this article appeared in print on September 16, 2010, on page F2 of the New York edition.
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