On October 6, 2021, BlackRock announced that it would be introducing annuities as a built-in option within BlackRock’s 401(k) plans. I believe that this latest product introduction in defined contribution retirement savings plans is a huge shift in the retirement planning industry and a bellwether for the state of personal retirement savings plans for most Americans.
To help provide additional context, here is a quick overview of the history of how the industry developed defined contribution plans. The retirement savings industry first started with a defined benefit plan in which companies created self-funded pension plans to create streams of income for employees when they retired. Then, the industry transitioned to 401(k) plans to shift the responsibility of savings onto employees along with the investment risk. As you can imagine, average savings per employee dropped dramatically after this transition.
In 2006, The Pension Protection Act was passed with the intention of boosting personal savings. This act allowed companies to automatically enroll new hires into a 401(k) target date fund as a default option. These target date funds grew to be one of the largest held asset classes in defined contribution retirement accounts. At the end of 2020, there was an estimated $1.9 trillion dollars in target date funds. BlackRock, one of the largest target date fund providers in the US with over $350 billion in target date funds, just announced a new target date product offering that has annuity-like features.
In 2019, BlackRock lobbied very aggressively to allow the inclusion of annuity-type options into retirement plans within The Secure Act. The question that arose, though was why Congress would allow annuities- which have historically had fees of 2-4% into savings plans- when Congress had pressured fund providers for the last decade to reduce 401(k) fees.
The Wall Street Journal explains that “With the U.S. population aging and employers shifting responsibility for retirement saving to individuals, lawmakers have grown concerned that a significant portion of Americans are at risk of outliving their money. Americans between the ages of 35 and 64 face a retirement savings shortfall of $3.83 trillion, with 41% of households projected to run short of money in later life, according to the nonprofit Employee Benefit Research Institute.”
Historically, employers disliked annuities because there was no legal protection from their choice of insurer. With the Secure Act, that dynamic has changed. Now, companies can use a new breed of products such as those BlackRock and many other companies have introduced as “Investment Only Annuities.” These products have all the essential benefits of an annuity without a mortality and expense fee, and no living benefit riders. By stripping down an annuity to its basic framework, expenses have gone down to 0.5%. With the announcement from BlackRock this last month, one of the largest money managers in the world is going head-to-head with the insurance industry. BlackRock’s ability to negotiate cheaper group rates and breadth of plan participants aims to reduce fees even more and has led industry experts to expect fees to become less than 0.25%, which is less than most mutual funds.
“We’re sitting between the end-individual and insurance companies, using our aggregation power to face off against the insurance company,” said Mark McCombe, BlackRock’s chief client officer.
BlackRock plans to roll out a new set of target date funds with built-in annuity features that are geared to individuals who are aged 59 to 72. These new funds will offer participants the ability to create their own pension within their existing 401(k) plan and thus allow individuals to determine how much of their 401(k) should be used to create a stream of income versus staying invested in the markets. On the backend, BlackRock plans to work with insurer Brighthouse to reinsure the pool risk.
Most of our clients are past the “transition phase” into retirement but their children will be faced with these options. I wanted to provide a framework for readers to see if this product is something that would benefit them.
There are several factors to include in any analysis to determine if this type of savings vehicle or strategy is a beneficial solution. The first step in this process is creating a financial plan to ensure you have saved enough for eventual retirement.
Once the plan is created, you will want to see how much of your essential expenses in retirement will be covered by guaranteed sources of income. Taking this analysis one step further, you will want to get a sense of your comfort around the percentage of expenses you want to be covered by fixed sources of income (i.e. annuities, pensions, Social Security) and their liquidity during retirement. Depending on your ability to take on risk, this percentage could range from 20%-60%.
If you believe you will be able to cover your essential expenses based on your guaranteed income sources during retirement, then an annuity feature within a 401(k) may not be the best solution. On the other hand, if you do not believe that you will be able to cover your essential expenses during retirement but that you will have savings during retirement that far exceed your expenses or if there is an eventual inheritance that minimizes the effect of volatility on periodic withdrawals, then you would also not benefit from this type of product. If you do not believe you will have excess savings to cover fixed retirement essential costs, an annuity will be a good product to consider to diversify market and longevity risk.