Once upon a time, retirees received pensions through defined benefit plans. Nowadays, instead, most employees have defined contribution plans—largely in the form of 401(k)s.
Lately, a growing number of 401(k) plans are offering annuities as an investment choice. Congress has even made overtures toward helping this trend along. Nevertheless, despite compelling arguments in favor of including annuities in these plans, some industry veterans are sounding the alarm. Wrapping an annuity inside a 401(k) could actually prove harmful, they warn.
Are they overreacting?
In simple terms, annuities offer security. While some peg account values to rises and falls in the investment markets, all annuities are basically contracts with a guaranteed payout. They are more insurance products than investment vehicles.
“Annuities are technically insurance to protect against longevity risk, or the risk of running out of money,” explains Michael Guillemette, a CFP Board ambassador and assistant professor of personal financial planning at Texas Tech University in Lubbock, Texas.
For the risk-averse, Guillemette says, annuities are a great replacement for the bond portion of a portfolio. But he adds that it doesn’t work the other way around. “Bonds are not a substitute for annuities, since the former don’t mitigate longevity risk,” he says.
Taxes And Other Considerations
One key objection to placing annuities inside 401(k)s is that both are tax-advantaged instruments. Combining them is sort of redundant—that is, it provides no additional tax benefit.