The Markets October 20, 2020

Consider Goals When Helping DC Plan Sponsors Select Annuity Options

Each type of annuity available to defined contribution plans has different features to match the goals of plan sponsors and participants.

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Understanding the types of annuities available to retirement plans and how they work is important for advisers to educate defined contribution (DC) retirement plan sponsors and help clients select the right option for their plans.

Immediate annuities begin paying out an income stream about six months after the time of purchase, whereas deferred annuities are scheduled to begin payments sometime in the future. A variable annuity is a type of annuity contract, the value of which can vary based on the performance of an underlying portfolio of mutual funds. Variable annuities differ from fixed annuities, which provide a specific and guaranteed return.

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“There are several considerations when looking at any annuity, including the objective of the funds, the time horizon and the tax consequences,” says Jason Field, a financial adviser at Van Leeuwen & Company. “The purpose of most annuities is to provide an income stream for retirement. Some reasons someone would want to include an annuity as part of a retirement plan would be for the income, and potential lower volatility with some upside potential. The drawbacks of having an annuity in a retirement plan are liquidity issues due to the surrender period of the contracts and potentially high fees.” He adds that some individuals may lose tax benefits of annuities by purchasing them with tax-deferred dollars in a retirement plan.

Field says a variable and/or a fixed annuity could be offered in a retirement plan, and either an immediate or a deferred annuity would make sense. “Depending on the time horizon of the individual, both variable and fixed annuities could be included in retirement plans,” Field says. “Variable annuities would typically fall under the equity portion of the retirement portfolio, since most of the funds in a variable annuity are tied to one of the stock markets. Fixed annuities would likely take the place of bonds in a portfolio since they do not move up and down with the market. Both—variable and fixed—could be used alone or in conjunction with one another inside of an account.

“If someone is looking for these assets to grow, then a deferred annuity would be the way to go. This would give the annuity time to increase in value based on the type of annuity it is. If someone is only looking to create a pool of money for lifetime income, then an immediate annuity would be more suitable.”

Matt Gray, assistant vice president of Allianz Life Insurance Company of North America, says the lifetime income aspects of annuities should make them attractive to retirement plan sponsors and participants alike. “Getting some protection against risks within retirement and guaranteeing an ongoing stream of income is a critical, yet often overlooked, component of a solid retirement plan,” he says. “The SECURE [Setting Every Community Up for Retirement Enhancement] Act has presented a significant opportunity for investment consultants and plan advisers to provide much needed information, education and guidance to the plans and the participants they serve. Doing so will increase the value they bring to their clients and help them achieve the best possible outcomes.”

Like Field, Gray says he believes that both variable and fixed, and immediate and deferred annuities can work within a retirement plan,. “Both fixed and/or variable annuities could certainly be appropriate for retirement plans depending on a given plan’s objectives,” he says. “For example, fixed annuities may provide for more predictability in growth and projected future income, along with a potential for lower fees. However, they may not offer the upside potential that a variable annuity could offer, which might be an important consideration for a plan given the current low interest rate environment.

“In terms of deferred versus immediate, again, it would really depend on the objectives of the plan,” Gray continues. “Does a sponsor want participants to be able to accumulate a level of future guaranteed income while they are working or do they prefer that participants make that decision at the point of retirement? Do they want it to be a part of a default offering or will it be opt-in only? There is value in having both options available, but does a sponsor have the bandwidth or appetite to put all that in place? These considerations can affect whether a sponsor prioritizes one over the other.”

Data & Research October 20, 2020

Stock Purchase Plan Expertise Helps Advisers Shine

The vast majority of employees that participate in both 401(k) and employee stock purchase plans say it is important to take advantage of financial guidance made available by their employer.

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Explaining the thinking behind a newly published Fidelity Investments survey, Mark Haggerty, the firm’s head of stock plan services, says part of the goal of the study was to dispel a longstanding misconception.

Historically, retirement plan industry experts have been concerned that employees who have access to a 401(k) and an employee stock purchase plan (ESPP) are faced with an “either/or” decision, Haggerty says. However, the freshly published Fidelity data demonstrates that when employees have access to both plans, in an integrated environment, combined participation is associated with better retirement savings behaviors and greater overall financial wellness.

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Fidelity’s findings are based on an analysis of more than 250,000 employees who have access to both a 401(k) and ESPP. The study shows that employees in both plans contribute an average of 12.5% and 6.3% of their salary in their 401(k) and ESPP, respectively, while employees that only participate in their 401(k) contribute an average of 8.8% of their salary.

Notably, the higher contribution rate for employees in both plans is consistent across all income levels, not just among executives or highly paid staff. For example, Fidelity’s data shows, employees with annual salaries between $25,000 and $50,000 who participate in both plans contribute an average of 8.3% and 4.7% to their 401(k) and ESPP, respectively, compared with a 7.4% contribution rate for employees that only participate in their 401(k).

These figures match data published last year by Schwab Stock Plan Services. At the time, Amy Reback, vice president of Schwab Stock Plan Services, told PLANADVISER that having a diversified portfolio of both taxed and tax-deferred savings is almost always a good strategy. ESPPs, unlike a traditional 401(k), are generally set up in a way that will result in participants contributing after-tax dollars, potentially reducing their income tax burden down the line. As explained by the publication MyStockOptions.com, plan sponsors can deliver special tax advantages to ESPP participants if the plan is structured to meet the requirements of Internal Revenue Code (IRC) Section 423.

Schwab’s 2019 survey found that, for those with an equity compensation plan, it makes up 27% of their net worth on average. Sixty-eight percent also hold company stock outside of their equity compensation plan, primarily in their 401(k) plan. Sixty-five percent were found to be very or extremely confident their equity compensation plan will help them meet their financial goals, and 28% were somewhat confident.

The fresh Fidelity data shows these dynamics have not changed during the coronavirus pandemic. If anything, they have solidified. Today, Fidelity finds, nearly nine out of 10 (89%) employees that participate in their company’s ESPP also participate in their 401(k), and employees that participate in both plans are more likely to take advantage of financial guidance made available by their employer, which can contribute to improved overall financial wellness.

As Haggerty emphasizes, when participation rates for employees in both their ESPP and 401(k) are analyzed by income, the analysis shows double-digit participation rates at every income level. The research also finds that participation in both plans was consistent among male and female employees.

The Fidelity research shows plan design matters as much for ESPPs as it does for a 401(k) or health care benefit plan. Simply put, an easier enrollment and account management process brings about potentially much higher participation.

One ESPP plan design feature shown to be particularly important is called a “look back” period. While ESPPs often offer workers the chance to purchase company stock at a discount, ranging from 5% to 15% off the regular price, many ESPP plans with a 15% discount also offer a look back period, which can stretch the discount when the stock price is appreciating. In other words, a look back compares the price at the beginning of the offering period to the price at the end of the purchase period and applies the discount to the lower price.

Fidelity’s analysis suggests that ESPPs offering a 15% discount with a look back provision have a participation rate of 44%—well above the participation rates for plans that offer lower discounts or no look back.

“This analysis demonstrates that while it’s important for employers to consider the workplace benefits they make available to their employees, it’s also important to recognize how the benefits are structured and the positive impact of offering employees multiple benefits in an integrated environment,” Haggerty says.

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