One of the biggest challenges retirees face is figuring out how to pay themselves.
People have been saving, saving, saving for years, but even those who have saved enough for retirement tend to freeze when it comes time to withdraw funds from their retirement accounts.
learn more: Retirement Planning – A Step-by-Step Guide
Starting next year, Vanguard has a solution: By partnering with TIAA, it will offer new retirement savings options to participants in its 401(k) plans. Simply put, it is an investment product modeled after a target-date fund with an annuity embedded within it.
“Vanguard’s goal is to make it easier to generate income from target-date funds in retirement,” Jason Kephart, a senior principal at Morningstar, told me. “If it fits with their retirement plan, adding an annuity to a target-date fund will give people an easier opportunity to have part of their portfolio as an annuity in retirement. They won’t have to deal with commissions or the overly complex annuity.”
Annuitization essentially refers to converting a lump sum portion of an employer’s retirement plan account into a guaranteed salary for a specified period or for the remainder of one’s life.
New products might ease deep-seated retirement worries: running out of money if we live long; having high health care costs as we age; or seeing the market decline instead of rebound quickly.
Participants will initially join a Target Retirement Lifetime Income Trust based on their expected retirement age of 65. While not technically called an account, the product is available within your employer’s Series 401(k) election and will initially operate like a typical target-date fund.
With these funds, you choose the year you want to retire and buy a mutual fund named after that year (such as Target 2044). The fund manager then divides your investments into stocks and bonds (usually made up of index funds) and adjusts them to a more conservative mix as the target date approaches.
In Vanguard’s new product, at age 55, a portion of your fixed-income savings is transferred to a TIAA Secure Income Account, a type of fixed annuity (an insurance contract that provides pension-like guarantees of growth and a lifetime income stream).
learn more: Fixed Annuity vs. Time Deposit: Which Is Better for Your Retirement Savings?
By age 65, the annuity portion will reach 25% of your account, and you can decide when to convert that portion into a salary. If you wait until age 72, your account will contain about 40% stocks.
A Vanguard spokesman said that much like other defined contribution plans, if you leave your employer and change jobs or are laid off and hold a Target Retirement Lifetime Income Trust, you can generally keep the money in the plan, roll it into an IRA, or cash it out. “The specific options for what participants can do will be defined by the plan sponsor,” he said.
There is no doubt that the savings gap increases the need for this traditional pension protection. Since 401(k) plans became the primary savings vehicle and largely replaced traditional pensions, retirement savers have shouldered much of the burden of setting up their own retirement savings accounts.
Read more: What is a 401(k): A guide to the rules and how it works
About 6 in 10 Americans will not be financially secure in retirement, according to Vanguard Group’s most recent Retirement Outlook report. Among workers aged 61 to 65, only the top 30% of earners are ready to retire.
Meanwhile, nearly half of workers say they need to save more than $1 million to retire, according to a new survey from Betterment. Fewer than three in 10 expected they would actually save that much money.
Vanguard is not the first company to combine target-date funds with annuities. For example, BlackRock’s LifePath Paycheck launches in 2024. No doubt more services will be launched as these accounts start to gain traction. The combination of annuities and Social Security benefits can alleviate many retirees’ concerns about monitoring investments, deciding which investments to draw from for living expenses, and weathering market fluctuations.
The problem is that annuities sold by insurance companies have a bad connotation for many people, and for good reason: They can be difficult to understand and have tiered fees. When you buy an annuity, you agree to hand over your savings to the insurance company and make it difficult to get them back.
I asked several financial advisors and experts what they thought of Vanguard’s new product.
TIAA’s Secure Income Account is a simple income annuity that will provide monthly payments for life in exchange for a lump sum, Kephart said.
But then he took a few steps back. “There’s still a big education gap … that needs to be addressed,” he said. “With embedded annuities, participants must understand how the income feature works, when to activate it and how it fits into their overall retirement plan.”
This requires some legwork. “Conventional target-date funds without annuities are designed to grow wealth during working life and gradually reduce risk as retirement approaches, rather than providing steady, predictable income in retirement,” he said. “Extra homework for investors goes against the reason why target-date funds are so popular — they require little effort.”
Target-date funds “solve the problem of how people save for retirement,” Preston Cherry, certified financial planner and president of Concurrent Financial Planning, told me. “They never really addressed how people would live on that money in retirement.”
“One of the biggest gaps in the U.S. retirement system is that we tell people how to accumulate, but when it comes to distributions we essentially leave them to their own devices. Retirement income planning comes at a time when decisions actually become more difficult. This kind of fund can help reduce anxiety, increase confidence in retirement spending, and can provide income certainty,” Cherry said.
Steve Parrish, professor of the practice and resident scholar at the American College of Financial Services, said the new Vanguard product “can be a great ‘middle’ concept” that offers “growth, but with guarantees.”
“The challenge is pricing and packaging. How do they price annuity guarantees to coordinate with target-date funds, and how do they package them so they work together? If just allowing target-date funds to be consolidated into a single-premium immediate annuity would feel more like window dressing than anything new,” Parrish said.
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Perhaps the most important component: education.
Pam Krueger, founder and CEO of financial advisor recommendation service Wealthramp, told me: “When guaranteed income products are packaged and delivered this way, more responsibility and potential liability shifts to employers and plan sponsors, who now need to educate and guide employees in making complex, often irreversible decisions.”
“We need to know exactly who is responsible for accounting for the true cost of these products, their liquidity, what the penalties are, and what happens if circumstances change,” Kruger said.
Retirees need help making decisions on a wide range of financial initiatives: spending, taxes, Social Security, and more. No embedded solution can do this alone.
“Guaranteed income may be useful; it may have a place. But without fiduciary advice, it risks becoming a default alternative to financial planning rather than a truly thoughtful option,” Kruger said. “If you don’t understand that, there’s a lot at stake.”
Kerry Hannon is a senior columnist at Yahoo Finance. She is a career and retirement strategist and the author of 14 books, including “Retirement Living: Gen X’s Guide to Securing a Financial Future,“”Taking Charge in Your 50s: How to Succeed in the New World of Work” and “You are never too old to be rich. “Follow her and continue blue sky and X.
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