To address the rising U.S. retiree population, some target-date fund (TDF) providers are now integrating annuities in their offerings to combat longevity risk and provide a stream of guaranteed income—but these vehicles may not suit all investors, a new report from Morningstar suggests.
Indeed, as the number of Americans nearing retirement continues to increase, the importance of ensuring a stable income and safeguarding against longevity risk is crucial, but navigating retirement-income products remains a challenge for both investors and their financial advisors, the firm explains in “Target Dates and Annuities … It's Complicated.”
For clients who plan to annuitize some or all their retirement savings, TDFs with risk protection provided by annuities may be a good option, but the decision shouldn’t be taken lightly, note the report’s authors, Jason Kephart, Director of Multi-Asset Ratings, and Samantha Lamas, Senior Behavioral Researcher.
“Target dates are one of the most popular ways investors save for retirement today, and they have proven to be a great tool for saving. In retirement, however, their benefits diminish,” Kephart and Lamas write. “These new strategies want to change that by giving investors the option to insure some, or all, of their nest egg. Products are only one component of the retirement-income dilemma, though. Another component—people—may be harder to solve for en masse,” the researchers further observe.
Expanding Lineup
Morningstar’s report comes as around a dozen new target-date series incorporating some form of annuity have launched (or plan to launch) since 2020.[1] Moreover, BlackRock will launch a new series this April, with about $25 billion committed from over a dozen defined contribution (DC) retirement plans.
“Although investor interest has been relatively muted to date (comprising less than 2% of target-date assets), we think BlackRock’s new series—slated to launch this month—will make a splash in this space,” Kephart and Lamas remark.
To be sure, there are advantages to bundling target dates and annuities. “For investors who plan to annuitize some of their assets, this package deal eliminates having to sort through myriad complicated options. Target-date providers choose the type of annuity, which varies by series, and then performs the due diligence on insurance companies,” the researchers explain.
That said, their complexity and fees may not make them suitable for everyone, they further emphasize. And because of participants’ poor adoption rates, one target-date series has already pivoted away from offering guaranteed income.
After 2024's first quarter, the Empower IncomeFlex Target series will no longer include annuities. According to the report, Empower found that 401(k) investors were not allocating enough to the TDF to generate enough guaranteed income to make the option worth opting into.
“This highlights that the biggest hurdle of these strategies is the lack of education,” Kephart and Lamas suggest.
Showing Promise
Still, target dates with annuities show that the industry is seriously considering how to help investors make retirement spending decisions, which is a step in the right direction, the researchers further stress.
“A lot of retirees who have used target dates to accumulate assets are familiar with the format and adding annuities to the vehicles can help users tackle the knotty problem of how to spend their nest eggs in retirement,” Kephart and Lamas note. “Combining target dates with annuities also can make annuities less intimidating by simplifying the annuity buying process, giving them flexibility, and allowing access to most of their assets in the target date.”
Regardless of annuities' benefits, investors need to consider their unique situations before buying one, even through a TDF, they note. For instance, some retirees may not benefit from annuitizing a portion of their assets or they may wish to have more control over their asset allocation. Moreover, these products do not offer retirees personalized advice.
“In other words, they may not be the right solution for some retirees because retirement income decisions are very personal,” Kephart and Lamas conclude.
To access Morningstar’s report, click here.
[1] The SECURE Act of 2019 gave managers more flexibility to manage retirement income. The law grants plan sponsors a fiduciary safe harbor when selecting insurance providers, lowering the legal risks of offering guaranteed income and opening a door for firms to offer such products.
