Should You Use a 401(k) to Buy an Annuity?

SmartMoney.com
Published October 22, 2009
by Aleksandra Todorova

…About a quarter of all companies these days offer their employees the option to purchase annuities with their 401(k) money, according to the Profit Sharing/ 401(k) Council of America, an industry group for plan sponsors. But these are lump-sum purchases that typically happen at the brink of retirement and aren’t too popular with employees, says David Wray, president of the PSCA.

What insurers have been working on during the past several years are specially-designed guaranteed-income products that can be purchased in small chunks with each paycheck, just like shares of a fund. ...

So far, sales of the products have been slow, according to Robyn Credico, the national director of defined contribution consulting at Watson Wyatt, a benefits consulting firm. But the products are being refined and improved, so industry representatives are hopeful that the tide is starting to change. …

If your employer offers any of the three guaranteed-income solutions – the option to annuitize at retirement, the ability to purchase annuity shares with each paycheck or invest in a mutual fund with an income guarantee – you should make sure it's the right solution for you. The three most important questions to ask:

1. What is the investment risk?

The much-touted guarantee is only there as long as the insurance provider behind it is healthy. … One solution the industry is considering is pairing up two or more insurance companies to back a product. In the meantime, employees can do their own research into the insurance providers’ financial health. …

2. What are the costs?

Adding an insurance aspect to any investment leads to higher costs – but how much of a premium you pay depends on the annuity provider. … “The quest right now for plan sponsors is to drive down costs as low as possible for their participants,” [Tom Idzorek, chief investment officer of Ibbotson Associates, a Morningstar company], says.

3. What is my exit strategy?

Another important question to ask your employer or 401(k) plan administrator before you start contributing: What happens to your investment if you change jobs? The insurance company will likely allow you to leave the investment in the plan, let you roll it over in an IRA, or will issue a certificate for you have accumulated so far. Make sure there are no penalties and you’ll keep the investment guarantee, Credico says.