Even as defined-benefit pensions continue to advance up the endangered-species list, 401(k) plans, a presumably hardier species, have hit some evolutionary bumps of their own.
Chief among them, of course, is the impact of the economic downturn, which left many plan participants with decimated account balances. The resulting outcry has prompted many employers — and policymakers — to look for ways to make 401(k) plans more effective. And part of their solution can be summed up in a single word: annuities.
The appeal of building annuity options into 401(k) plans is simple. Unlike mutual funds, which dominate discussions of 401(k) investment strategies, annuities promise to deliver guaranteed payments to retirees for their entire lifetime. They also allow employees to see how much income they have accrued for retirement at any given time. And, for employers jettisoning traditional pension plans and emphasizing a switch to 401(k) plans, offering annuities provides at least the appearance of a pensionlike guarantee.
But the biggest driver is employee demand for more certainty. In 2007, for instance, Paychex, a payroll and human-resources outsourcing firm that administers 401(k) plans for other employers, began offering an annuity as an investment option in its own defined-contribution (DC) plan. The reason was that “our employees, who were feeling the downside of 401(k)s becoming, as the joke goes, ’201(k)s,’ were asking for it,” says Will Kuchta, the company’s vice president of organizational development.
Many Paychex employees had invested heavily in the company’s stock and saw their savings dwindle in the wake of the dot-com bust. Some began to request traditional pensions like the ones police officers, firefighters, and teachers routinely get, according to Kuchta. The firm’s answer was to offer a Genworth Financial Services annuity that resembles a pension in that enrollees receive guaranteed periodic payments upon retirement.
As is the case with any other form of 401(k) investment, however, the bulk of retirement income is funded by employee contributions rather than employer contributions.
Nevertheless, employers and benefits policymakers feel the time is ripe for a serious look at annuities as one piece of a broader strategy to fill the gap in retirement income that many employees face. The demise of traditional pensions and increased anxieties about the risk of investing in debt and equity mutual funds have added a certain urgency to the subject. “We’re used to living from paycheck to paycheck,” says Jody Strakosch, national director of strategic alliances for MetLife’s retirement-products group. The use of annuities in DC plans represents “a way of getting that paycheck in retirement.”
To date, Paychex is part of a tiny minority of employers actually offering annuities as a 401(k) plan option. “We have not seen an overwhelming demand from plan sponsors” for the use of such products, says Beth McHugh, a vice president with Fidelity Investments. Indeed, of the 19,000 defined-contribution plans that the mutual-fund company administers, only one offers the choice of an annuity — and only 10% of that plan’s employees participate in it.