Should you buy an annuity inside your 401(k)?

Choosing how to fund your retirement is one of the biggest financial decisions you’ll make. Traditionally, 401(k) plans have relied on investments like mutual funds and target-date funds, which provide a mix of different assets like stocks and bonds. 

But with the SECURE Act and SECURE Act 2.0, legislation that ushered in sweeping changes to retirement plan offerings, annuities are showing up in more 401(k)s. 

An annuity can provide guaranteed income for life, offering peace of mind as pensions disappear from the private sector. But is an annuity inside your 401(k) a good idea? 

In this article, we’ll explore the growing trend of in-plan annuities, potential drawbacks and whether this offering makes sense for your retirement strategy.

The rise of in-plan annuities

In 2020, Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act, which was soon followed by SECURE Act 2.0 in 2022. Both laws make it easier for employers to add annuities to 401(k), 403(b) and 457 plans.

Specifically, the laws provide protection for fiduciaries and employers who include annuities in their retirement plans. Previously, employers could potentially be held liable if the insurer providing the annuity went out of business. The SECURE Act’s “safe harbor” provision clarified that plan sponsors can rely on the insurer’s claims of financial strength, shifting part of the due diligence burden away from employers. 

More workers and employers are interested in an annuity option

In March 2023, just 15 percent of private sector employees had access to a pension at work, according to the Bureau of Labor Statistics. With pensions nearly extinct in the private sector, many retirees worry about outliving their savings. In-plan annuities offer a solution — a stream of income that can last a lifetime.

Nearly 70 percent of non-retired workers ages 40 to 80 with at least $100,000 in investable assets said they would be “very” or “somewhat” likely to select an in-plan annuity if offered, according to a May 2024 survey by LIMRA, an insurance company trade association. Participants between the ages of 40 and 49 were especially interested in the annuity option, the survey found. 

Workers aren’t the only ones interested in predictable retirement income. Plan sponsors are also exploring their options. 

According to a 2024 TIAA study, 76 percent of defined contribution plan sponsors expect demand for annuities to grow significantly by 2030. 

The research also found 40 percent of plan sponsors without an annuity option intend to offer one by 2027, according to the TIAA survey. Large employers are leading the charge. 

How does an annuity inside your 401(k) work?

Annuities are a contract with a life insurance company in which you hand over a lump sum or series of payments in exchange for a promised stream of income in retirement. However, annuities are notorious for their complexity, and depending on the type of annuity, these arrangements can be rife with fees and hidden commissions. 

Since the SECURE Acts opened the door to annuity offerings inside retirement accounts, major players have jumped on the opportunity to bring new products to market, often in a familiar target-date fund wrapper that functions quite differently than a traditional annuity purchased directly from an insurer.  

A hybrid of annuities and target-date funds

A target-date fund is a diversified investment fund designed to automatically adjust its asset allocation as you approach a specific retirement date. These funds, which serve as cornerstones of many 401(k) plans, typically shift their allocations from riskier investments like stocks to more conservative options like bonds over time. 

The target-date funds with an annuity twist offered by companies like BlackRock, JP Morgan and TIAA function in a similar way. 

The participant chooses their target date, aka the year they plan to retire. As that date approaches, the fund begins allocating a portion of contributions to a separate income fund, which can later be converted to an annuity issued by a partnering insurer. Once in retirement, the participant receives annuity payouts directly from the insurer. 

So with an annuity inside your 401(k), you’re not directly buying the annuity; you’re essentially buying the option to purchase an annuity down the road. 

Drawbacks and considerations for in-plan annuities

New in-plan annuity options may carry lower fees than purchasing certain annuities on the open market, but they probably cost more than the fees charged by traditional target-date funds, in part because both the fund provider and the insurer receive a cut. 

As the disclosure for JP Morgan’s SmartRetirement Lifetime Income Fund points out, JPMorgan “will charge an all-in management fee…plus certain service fees.” It goes on to state that plan participants who opt in to the annuity feature will also get charged a premium by the issuer of the annuity contract.

And these new retirement offerings are far from uniform — some provide fixed payouts, while others offer variable payouts with complex underlying mechanisms. Unlike mutual funds or ETFs, they lack standard regulatory filings or ticker symbols, making them harder to compare. With often unclear fees and limited public information, the onus is on employees to carefully evaluate an annuity’s specific features before opting in. 

Even if a worker is interested in an annuity option inside their 401(k), not all plan sponsors and fiduciaries are on board. 

Despite flexibility provided by the SECURE acts, when an annuity is offered through a retirement plan, plan fiduciaries are still responsible for thoroughly evaluating the offering and the financial health of the insurer, says Michelle Gordon, chief operating officer at Axonic Insurance Services.

“I also believe all fiduciaries are responsible for checking the creditworthiness of all recommendations,” she says. “And I think the SEC doesn’t consider relying blindly on rating agency guidance as acceptable research by a fiduciary.”

Given the complexity of annuities, plan fiduciaries may be understandably skeptical of folding these financial products into their plans.

“I think what’s holding plan fiduciaries back is all the years they’ve heard about how expensive annuities are when they’re sold on commission outside of plans,” says Gordon. “They don’t yet know or understand the products, so they don’t feel well-educated in the space.”

This tracks with findings from TIAA’s survey, which found only 37 percent of sponsors feel confident explaining the value of annuities. For those not planning to offer annuities, 43 percent cited a lack of understanding as the main reason.

Pros and cons of in-plan annuities

Pros

• Guaranteed lifetime income
• Protection from market downturns
• Simplifies retirement planning
• Fiduciary oversight from plan sponsors

Cons

• Limited access to funds once annuity payouts begin
• Fees can be high
• May not keep up with inflation
• Lack of flexibility in payout options
• Insurer insolvency risk, though some of this risk is mitigated by safe harbor provisions

Should you buy an annuity inside your 401(k)?

Deciding whether to buy an annuity inside your 401(k) requires careful consideration of your specific financial situation and risk tolerance. 

For many retirees, an in-plan annuity offers the opportunity for peace of mind. If you’re concerned about outliving your savings, an annuity can act as a kind of longevity insurance, ensuring continuous payments no matter how long you live. 

Annuities can also simplify retirement planning by reducing the need for active investment management and careful withdrawal strategies. So if the thought of managing your portfolio as you grow older doesn’t sound appealing, opting for an in-plan annuity could ease anxiety about market volatility or mismanaging your investments. 

However, annuities aren’t for everyone, and they tend to be incredibly complex compared to other investment options. These financial products limit liquidity, making it difficult to access your money once payouts from the insurer begin. Unexpected expenses, like medical emergencies or home repairs, could leave you in a bind if you don’t have enough cash set aside elsewhere. 

Fees can also be significant, cutting into returns compared to other investments, like traditional target-date funds or index funds. If maintaining flexibility and control over your money is a priority, an annuity likely isn’t a good fit. 

Finally, life expectancy is another consideration. If you have health concerns or a shorter family lifespan, you might not receive enough income from an annuity to justify the cost. 

Ultimately, choosing an annuity within your 401(k) is a personal decision. If predictable income, longevity protection and simplified financial management appeal to you, it’s worth exploring an in-plan annuity if your workplace offers one. But if flexibility, transparency and access to your money are more important, it’s best to explore other alternatives. 

A financial advisor can help you weigh these pros and cons and build a retirement strategy aligned with your goals.

Bottom line

In-plan annuities are gaining traction as a way to provide income for retirees. While they can offer valuable peace of mind, they aren’t a one-size-fits-all solution. At the end of the day, the decision to buy an annuity inside your 401(k) should align with your long-term retirement goals. Consult with a financial advisor to fully explore your options. 

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.