Hybrid annuity target-date funds (TDFs) could be valuable for some investors, as more search for retirement planning tools embedded with guaranteed income options, finds a recent analysis by Vanguard.
For participants wanting to build retirement savings, hybrid annuity TDFs offer growth and the ability to create a “pension-like” stream for retirement, says Vanguard experts.
“While traditional target-date funds have become a tool that more than half of all 401(k) participants use to build their retirement savings, it’s much harder to find broadly suitable products to help retirees turn their retirement savings into income,” said Roger Aliaga-Díaz, Vanguard’s global head of portfolio construction and chief economist, Americas, in the research.
According to Vanguard, “in this type of fund, the allocation to a growth-focused multi-asset portfolio like that of a traditional TDF is decreased ahead of retirement to prefund the purchase of an annuity that is expected to provide a certain level of guaranteed income throughout retirement.” The amount of prefunding used to buy an annuity is up to the investor, adds Vanguard.
The research touches on the three types of fixed-rate annuities commonly used, depending on when retirees would want to begin receiving income. These include:
- Single premium immediate annuity (SPIA), which starts providing income immediately after the annuity purchase.
- Deferred income annuity (DIA), which begins providing income at a future date after the annuity purchase, and;
- Qualified longevity annuity contract (QLAC), which provides income at a later stage of retirement (age 78-plus). This deferred annuity is exempt from required minimum distributions (RMDs).
While Vanguard does not currently offer hybrid annuity TDFs, the registered investment advisor (RIA) used its Vanguard Life-Cycle Investing Model (VCLM) to understand the added benefits investors could gain from blending annuities into traditional TDFs. Vanguard’s VCLM creates glidepaths by assessing custom investment portfolios to create the best solutions for investors.
“Using VLCM, we can measure the degree of improvement in an investor’s ability to afford expected living standards throughout retirement, the reduction in the risk of outliving one’s wealth, and mitigation of market risk when using a hybrid annuity TDF versus a traditional TDF,” added Aliaga-Díaz.
Vanguard’s research found that hybrid annuity TDFs could deliver higher investment value for retirees across all three types of annuities, dependent on factors including design, timing, the amount, and the kind of annuity used. According to the VCLM, the overall improvement in value to investors ranged from 0.24% for an SPIA to 0.48% for a QLAC.
However, even in considering its benefits, Vanguard notes that such products may not bode well for other investors, depending on limits regarding suitability, complexity, and cost. For example, whereas traditional TDFs are considered a “one-size-fits-all” solution with little involvement from the investor, hybrid annuity TDFs require the investor to take a hands-on approach when determining what their optimal purchase amount is, depending on their individual income needs.
“While hybrid annuity TDFs show promise in providing a more secure retirement, they also introduce complexities and higher costs,” concluded Aliaga-Díaz. “Addressing these challenges through strategic planning and tailored solutions could make hybrid annuity TDFs a viable option for a broader range of investors, ultimately leading to more personalized and effective retirement outcomes.”
SEE ALSO:
- Recommendations to the ERISA Advisory Council Regarding Target Date Funds
- Ascensus to Buy Vanguard’s Individual 401(k), Multi SEP, and SIMPLE IRA Plans
- Inflation and Unemployment Decline While Account Balances Grow: Vanguard
Amanda Umpierrez is the Managing Editor of 401(k) Specialist magazine. She is a financial services reporter with over six years of experience and a passion for telling stories and reporting news. Amanda received her degree in journalism and government and politics at St. John’s University. She is originally from Queens, New York, but now resides in Denver, Colorado with her partner. In her free time, Amanda enjoys running, cooking, and watching the latest drama show.
