Generating Retirement Income Just Got Easier—or Did It?

Key Takeaways

• Target-date funds are a great way for the average person to save for retirement. These are typically the default options on 401(k) plans. That’s how most investors access them. So, for hands-off investors, they are great.
• These new target-date funds are trying to build off the success we’ve seen in target-date funds, which had about $3.5 trillion in assets as of the end of last year, and sneak in a guaranteed-income option. So, as you’re getting closer to retirement, you’ll start accumulating assets that can be converted into an annuity at retirement.
• The option to annuitize is good for people in the middle class. If you’re at the lower end of the income spectrum, Social Security is going to replace a lot of your income in retirement.
• Target-date funds with annuities are available through collective investment trusts, which are only available through 401(k) plans. It’s going to be up to your plan sponsor to really decide if it’s an option for you or not.

Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Making the shift from accumulating assets to living off those accumulated assets can be a difficult change for some retirees. But a new type of target-date fund might make generating retirement income a little easier. Joining me today to discuss these new products and who might benefit from them is Jason Kephart. Jason is director of multi-asset ratings with Morningstar and co-author of some new research called “Target-Date Funds and Annuities … It’s Complicated.”

Hi, Jason. Good to see you.

Jason Kephart: Thank you for having me, Susan.

Target-Date Funds During the Accumulation Phase and Drawdown Mode

Dziubinski: Let’s start out with a recap of how the standard target-date fund generally works both during the accumulation phase and then when you’re in drawdown mode.

Kephart: Sure. Target dates are an awesome way for the average person to save for retirement. These are typically the default options on 401(k) plans. That’s how most investors access them. So, for hands-off investors, it’s great. You start off with a portfolio that’s heavy in stocks because you want to maximize growth when you have a long timeline. Then as you get closer to retirement, the portfolios gradually get more conservative because once you’re growing the money, you want to start protecting it once you get into retirement. When you’re in retirement, however, a target-date fund just turns into a normal portfolio. Some of them might still be moving more conservative as you’re moving through retirement. But for the most part, there are no real additional benefits. The things that really help you in saving for retirement are things like auto-enrollment, auto-escalation, not paying attention to your 401(k), but in retirement, you really have to start paying attention. So, all the things that make target-date funds great for saving for retirement, they’re not really there in retirement. So, I think there’s a new push to have these new products that might make things a little bit easier, but we’ll see.

New Target-Date Funds and Annuities

Dziubinski: OK. Well, then let’s segue right into those. We have several target-date fund providers in the last couple of years that have been launching these new types of target-date funds that incorporate some form of annuity at the end. Walk us through how these new vehicles work.

Kephart: I think the real impetus is people are living longer, and so the risk of running out of money in retirement is higher than it’s been in the past. So, you need some kind of a guaranteed income source. For most people, they’re going to rely on Social Security, but that might not be enough. So, these new target-date funds are trying to build off the success we’ve seen in target-date funds, which have about $3.5 trillion in assets as of the end of last year, and try to sneak in a Trojan horse kind of guaranteed-income option. So, as you’re getting closer to retirement, you’ll start accumulating assets that can be converted into an annuity at retirement. That way you don’t have to go out and try to find your own annuity if that’s what you want. So, most of these are opt-in. You’ll see exactly what the benefit will be when you opt in, the amount of monthly income you’ll get or the amount of withdrawals you’ll be willing to take or able to take. So, I think that’s what makes these new target-date funds different.

Which Asset Managers Are Offering New Target-Date Funds?

Dziubinski: Which asset managers as of today offer these target-date funds with annuities and what’s the uptake been like?

Kephart: We’re starting to see more uptake. BlackRock is launching one in April, any day now, called BlackRock LifePath Paycheck. That’s going to have about $25 billion in it. AllianceBernstein does one through a custom target-date fund option that’s got about $10 billion. There are a handful of others that really haven’t started to see pickup yet, but major providers like Nuveen, American Funds, and American Funds partnering with insurance companies. So, you’re starting to see more household names adopt this structure. I do think if we see success with the products that are out now, you’re going to see all the major target-date fund providers follow suit.

Who Will These Target-Date Funds Be a Good Choice For?

Dziubinski: Who might these target-date funds with annuities be a good choice for?

Kephart: I think the option to annuitize is good for people kind of middle-class. If you’re at the lower end of the income spectrum, Social Security is going to replace a lot of your income in retirement. So, that’s not as much of a concern. If you’re at the really higher end of the income bracket, running out of money is not going to be your primary concern. So, it’s kind of the middle-class investor who maybe is right on the cusp of whether or not they can afford or need a financial advisor. There’s also the peace of mind that comes with an annuity. There’s a cost to it, but there is a peace of mind, and I think some people will just sleep easier at night knowing that at least a portion of their savings is going to guarantee them some kind of an income stream.

Target-Date Funds With Annuities, 401(k) Plans, and IRA Rollovers

Dziubinski: Jason, can investors access these target-date funds with annuities outside of a 401(k) plan? Say if you have a 401(k) you want to roll over into an IRA, is something like this an option for you or no?

Kephart: Right now, it’s not. They’re only available through collective investment trusts, which are only available through 401(k) plans. We haven’t seen any providers launch a mutual fund version yet, which is what would be more accessible. For now, it’s only through your 401(k) plan. So, it’s going to be up to your plan sponsor to really decide if it’s an option for you or not.

Will Target-Date Funds With Annuities Help With Retirement Income?

Dziubinski: Then lastly, are these target dates with annuities really an easy solution that we’ve been all been waiting for to help us with retirement income? I would guess based on the title of your article, “Target Dates and Annuities … It’s Complicated,” maybe it’s not so easy but tell us what you think.

Kephart: It’s not the easy button. There’s a lot of complexity and education that needs to be done to get people to understand these and understand what they’re getting into and what their options are. So, I think it’s not the easy button, but it’s a step forward that makes things easier for people who do want to annuitize a portion of their income in retirement. But I think it’s too soon to say whether or not these target dates with benefits are really going to take off.

Dziubinski: Well, Jason, thank you for your time today. This went a long way toward getting some of that education out into the world. We appreciate it.

Kephart: Thanks for having me.

Dziubinski: I’m Susan Dziubinski with Morningstar. Thanks for tuning in.

Watch 3 Great Balanced Funds for more from Jason Kephart.