Is Guaranteed Income the Next Frontier for Target-Date Funds?
The SECURE Act opens the door for annuities in target-date funds.
Morningstar's 2020 Target-Date Strategy Landscape covers the current trends driving target-date funds, but the freshly passed SECURE Act could have a big impact on the future of these retirement savings vehicles.
In December 2019, Congress passed the SECURE Act, a retirement readiness bill that included new rules to make annuities more accessible for defined-contribution plans. Previously, plan sponsors assumed liability for all the typical investment risks that come with a security--such as costs, process, and execution--but for annuities, they also bore responsibility for the unique hazard of the insurer defaulting on the contract. Given the long time horizon attached to annuities, plan sponsors were not willing to take on that risk. Under the SECURE act, employers are now mostly shielded from that liability if the insurer defaults, as long as that insurer meets creditworthiness requirements at the time the decision is made.
While there have been some custom target-date mandates that include annuities, like the Yale Target-Date Plus Model Series managed by TIAA-CREF (an insurance company with an asset-management arm), only one target-date series with a guaranteed income option is broadly available today. Prudential, also an insurance company with an asset-management arm, launched its IncomeFlex series in 2009. For the most part, it resembles a typical target-date series and offers relatively low fees; the 2060 through 2035 funds charge 0.35% or 0.34% for their institutional share classes. Fifteen years from retirement, the investor has the option to convert a portion of assets to the guaranteed income option. The earlier the investor commits within that 15-year window, the higher the rate of income they can lock in. Locking in the option, however, adds an additional 1.00% fee. The 2020 fund, for example, charges 1.34% if that option is exercised.
It's not surprising to see the guaranteed income option result in higher fees. Indeed, high fees have been a common criticism of annuities. And given the long-term trend toward low-cost target-date funds, it's a potential headwind to widespread adoption among plan sponsors.
One potential disruptor is BlackRock, which has filed with the Securities and Exchange Commission to launch a new version of its LifePath target-date series that will include a guaranteed income option. It's expected to launch in the second half of 2020. Since the series is still in registration, details are scarce, but if BlackRock can leverage its scale to get an insurance company to agree to fees more in line with the norm in target-date funds, it could open doors that were previously closed. Other target-date sponsors that we've spoken to are monitoring the change in regulation, and if a series does gain traction, it likely won't be long till others follow.
Of course, the inclusion of a guaranteed income option raises myriad due-diligence questions that an investor needs to understand before making a decision. As options emerge, we'll be keeping a close eye on fees, how the contracts are structured, and the option's impact on the glide path.