Target Date Strategies With Annuities: A Guide for Asset Managers

As the number of Americans nearing retirement increases, so does the importance of ensuring a stable retirement income. To address this challenge, asset managers are turning to a new strategy—combining the familiarity of target-date funds with the longevity protection and volatility reduction provided by annuities.

When you have a better understanding of the evolving role of annuities within target-date funds, you can deliver the right offerings. Our Morningstar researchers take a deep dive into this new wave of target-date strategies.

To read the full research report, download a copy.

As a form of guaranteed income, annuities are designed to combat longevity and market risk. They can also tackle many behavioral obstacles in retirement-spending decisions by making withdrawal payments automatically and providing a steady paycheck. Still, not many retirees purchase annuities for various reasons, like their complexity and lack of flexibility.

Enter target dates—one of the greatest retirement savings innovations. They offer professionally managed portfolios of stocks, bonds, and other investments that start off emphasizing growth and then gradually become more conservative as their target retirement dates approach. Target dates' extensive use also makes them a natural starting point and are easy buttons for investors who don’t want to manage their own money.

Considering that annuities come in many different forms, our researchers separate them into two groups based on what they offer: income annuities and savings annuities.

These annuities provide a guaranteed stream of cash in exchange for a lump-sum payment. Still, inflation can erode purchasing power of the fixed payments over time. But using an income annuity as a part of a bond portfolio may help improve outcomes, since it allows investors to take more risk in other parts of their portfolio to offset inflation. Also, the guaranteed payments provide peace of mind for some.

Income annuities are incorporated into target dates in two ways: Under the first approach, investors have the option to buy an income annuity with a portion of their balance at the retirement target date. With the second approach, the target date buys units of guaranteed income before the target retirement date. In other words, the target date buys a series of deferred-income annuities.

Both cases allow investors to access their funds until they choose to annuitize or turn on the income stream. There’s also no explicit fee attached to income annuities. Instead, the fee is baked into the guaranteed payment.  

When it comes to savings annuities with a guaranteed lifetime withdrawal benefit (GLWB), they don’t require investors to surrender control of their investments—and they potentially have more upside than income annuities.

GLWBs allow investors to withdraw a certain percentage of assets each year. Target dates incorporate GLWBs in two ways: When the underlying contract is a variable annuity, the GLWB is wrapped around the funds' total investment. Alternatively, the GLWB can be wrapped around a fixed index annuity sleeve within the target date. The guaranteed income from the fixed index annuity supports the targeted income rate and any fund-level promises.

The GLWB is typically based on the account balance or the account balance’s high-water mark before withdrawals begin. And the longer an investor can delay withdrawals, the bigger the payment—but the payments are typically not as generous as those of income annuities because they offer more flexibility in retirement. Savings annuities can also have both explicit and implicit fees.

Combining target dates and annuities may help many investors. In fact, the strategy can make annuities less intimidating by simplifying the annuity buying process and allowing access to most of their assets in the target date. When asset managers know the benefits and complexities of these innovative funds, it can be easier to provide unique options.

Differentiate your business with Morningstar’s Personal Target-Date Fund Services. While annuities won’t be included, the technology platform takes unique data points for each participant—such as a participant’s age, income, account balance, and contribution rate—to build an offering that’s more tailored to investors and their individual retirement goals.