Annuity IQ

In a recent Investmentnews.com article there was a debate about annuities in 401 (k) plans, specifically adding immediate annuities to these plans. While I generally agree that adding an income annuity to a retirement plan may not be a bad idea I do disagree with the idea that variable annuities are a bad retirement plan vehicle.

Immediate annuities are fine investments with a specific goal, they generate income. What they do not do is generate increasing income over the long term, generally speaking of course. The primary motivation and appeal to immediate annuities is the simple fact that it will generate income for as long as you live, a good thing. The problem is what about inflation?

Immediate annuities stink against hedging for inflation even though there are some immediate annuities that do provide cost of living increases every year. The inflation hedge that you can opt-in for with these contracts means smaller income now for larger income later.

Using a variable annuity on the other hand, even with higher fees, with a living benefit inside a 401 (k) plan is essentially the same thing and, in fact, more effective. Contrary to popular belief using the variable annuity gives the participant the option of investing how they choose, either aggressively or more conservative, at the same time the participant will not have to worry about market losses. This would allow for a hedge against inflation while providing lifetime income for the participant.

We all know what happened a few years ago with the market decline so wouldn’t it make sense to use a product that could lock in your gains to provide you with future income? Wouldn’t this reduce the plan sponsors fiduciary responsibility? I think so.

Here is why, during the market correction employees started suing their employers for breach of fiduciary responsibility because their 401 (k) plans lost money and they did not have adequate investment options, safer investment options. This is, of course, after employees sued their employers for not offering low cost investment options in the late 1990’s.

Now, if the employer used a variable annuity with a living benefit, that locked in gains for either lifetime income guarantees or return of principal, and protected the employee from market down turns there would be little complaining by the plan participants. If this happened all of those ‘paper’ gains from the 1990’s would have been saved. Those gains would have reset the guarantees of the 401 (k) and the employee could rest assured that their future income would still reflect those massive gains. The employer would then have fulfilled their fiduciary responsibility and there would be little or no litigation.

Instead, variable annuity critics, say no way the extra cost is not worth it and scare participants and employers from offering such plans. What the critics do not grasp is how these benefits work and why they make sense in retirement plans. All the critics can see is an extra fee paid and the imaginary ‘double tax deferral’, which is just a plain stupid argument to begin with, and not the vast advantages of the variable annuity.

What the critics do not understand is that many people will not invest in their 401 (k) plan, or invest too conservatively, because they do not like the stock market. They do not understand that some people will only invest in money market accounts inside of their retirement plans. This is because many participants fear risk and because of this fear the participants are contributing to the amount of people not saving enough for retirement.

A variable annuity with a living benefit inside of a 401 (k) plan can help eliminate that fear. If the investor realizes that they could invest without the worry of market losses they would take advantage of the retirement plan. Yet, the critics think they are doing everyone a service by trying to save them money, and they are to a certain extent, but at the same time the pennies they may be helping people save could cost the participant thousands in market losses.

I think if there were more low cost variable annuity plans available the critics would be more accepting of these plans. If you had a product that could lock in gains for future income and a death benefit guarantee for the participant’s heirs for a reasonable cost what would there be to complain about.

In my opinion using a variable annuity instead of an immediate annuity makes much more sense. You have a hedge against inflation and you have downside protection while at the same time you will have guaranteed future income.