Understanding In-Plan Retirement Income Fees

As more plan sponsors consider incorporating lifetime income options into their retirement offerings—and more such options come to market—they are confronting a range of solutions that also come with a range of fees.

“The key thing that we always advise fiduciaries on is that fees, in and of themselves, aren’t bad or good,” says Michael Kreps, a principal in Groom Law Group. “It’s just a cost, and you have to weight them against the benefits that are being provided.”

Some options, such as retirement income and Social Security calculators and income-oriented fixed-income funds, have negligible costs, but other options come with significant price tags. In general, guaranteed income options, such as in-plan annuities or target-date funds with a guarantee, cost more than nonguaranteed options, given the higher level of risk associated with the former.

“We’re talking about products that have lots of features, lots of considerations for fiduciaries: the level of the guarantee, the administrative support for the program, the portability options and how it integrates with the recordkeeper,” says Kreps. “These are all things that have to be considered in light of the fees.”

Generally, in-plan options still tend to cost significantly less than retail annuities purchased on the open market, and costs are not the primary reason for plans to hold off on adopting in-plan solutions. A 2023 survey conducted by LIMRA found that just 19% of plan sponsors without an in-plan annuity said cost was the reason. More common reasons for not purchasing an in-plan annuity included a belief that there was no worker demand (26%), feeling it is the employer’s responsibility (22%) and other benefits responsibilities (22%).

When it comes to evaluating fees, there are not great benchmarks available, Kreps concedes, because many of the products are new, and also because the providers have differentiated themselves with structurally different solutions. But, he says, it is possible to benchmark their components, such as their target-date fund or their lifetime withdrawal benefit.

Common Structures

As the market continues to evolve, pricing models will as well, but some common structures have emerged. Phil Maffei, senior managing director of corporate retirement income products at TIAA, categorizes most of the fees associated with income into three buckets: transactional fees, omnipresent fees and those without explicit fees.

Transactional fees are those that occur at the purchase of the annuity, typically for plans that facilitate an in-plan annuity purchase from an approved provider. The participant would pay a commission at the time of purchase. So, for example, a few thousand dollars per each $100,000 annuitized might go to the provider.

Omnipresent fees would apply to some so-called living benefits, or guaranteed lifetime income withdrawal benefit withdrawal products in managed income or some target-date products. These products typically include both an investment management fee, as well as a guarantee fee, typically about 100 to 110 basis points, based on how much is invested.

“The downside there, of course, is if you decide not to turn on the lifetime income option, you’ve effectively paid for a benefit that you haven’t received,” Maffei says.

Finally, there are fixed annuities without explicit fees. These are pure, spread-based insurance products.

“We expect a certain amount of interest on the investments, so we’re going to credit a certain amount of interest,” Maffei explains. “Then what’s left is used to build capital and build reserves and pay investment expenses.”

‘Similar to an Indexed Target-Date Fund’

There are other models as well, combining the above approaches. BlackRock’s Lifepath Paycheck target-date fund allocates the non-equity portion of participants’ portfolios to a pool of annuity contracts, which acts as bond funds would in a traditional target-date fund. Starting at age 59.5, participants use that portion of their portfolio to purchase a traditional, fixed annuity that begins to pay lifetime income immediately, with implicit, spread-based pricing.

“Participants pay a fee similar to an indexed target-date fund, and there are no commission or surrender fees when they elect to purchase the annuities from insurers,” says Rob Crothers, head of U.S. retirement at BlackRock.

LifePath Paycheck launched in April and can be used as a qualified default investment alternative. Currently, participants who choose to purchase the annuities will receive lifetime income from insurance companies Equitable or Brighthouse Financial.

T. Rowe Price also has a target-date income solution that it claims has no additional cost to participants. That product, a nonguaranteed managed-payout fund, targets an annual 5% withdrawal rate. Launched in 2019, that product now has 59 plan sponsors enrolled, representing $20 billion in assets.

“We’ve really anchored around a pricing methodology that seeks to be consistent with the target-date experience,” says Jessica Sclafani, a global retirement strategist with T. Rowe Price. “But I understand that for plan sponsors, as fiduciaries, cost is a consideration, and it should not be considered in a vacuum.”

Making Trade-offs

To that end, T. Rowe Price has published a “five-dimensional framework” to help plan sponsors evaluate retirement income solutions for their participants. The framework’s dimensions include longevity-risk hedging, level of payments, volatility of payments, liquidity of balance and unexpected balance depletion.

Sclafani says fees would fall under “level of payments,” since achieving that might require sacrificing one of the other four framework considerations (likely liquidity) and pushing up the overall cost.

Annuities embedded in target-date funds make sense, and their cost is easy to benchmark, says Barbara Delaney, founder of SS/RBA, a division of Hub International, but they present challenges if the plan sponsor later decides to switch providers or the plan participant separates from the plan. Such situations could become a fiduciary liability issue for plan sponsors.

“The attorneys will jump in and say that [participants] paid for something that they never used,” Delaney says.

She believes income products need to continue to evolve, with plan sponsors and the industry focusing first on helping plan participants understand the retirement process—and then helping them find the appropriate solutions.

Another issue she cites is recordkeepers that still charge participants for individual distributions, ranging from $50 to $125 apiece, a policy that can add up quickly when following a drawdown strategy.

“I empathize with the recordkeepers, because it’s a hard-coded system that they’ve built,” she says. “But if they’re trying to keep money in the plan, they shouldn’t make it difficult to take withdrawals. They’re almost forcing retirees to get out of the plan.”