(Yahoo!Finance) - One of the biggest challenges for retirees is figuring out how to pay themselves.
For years, it’s save, save, save, but when it comes time to pull money out of retirement accounts even people who have saved adequately for retirement tend to freeze.
Starting next year, Vanguard has a solution: Through a collaboration with TIAA, it will offer a new retirement savings option for participants in its 401(k) plans. In simple terms, it’s an investment product modeled on target-date funds that comes with an annuity embedded into it.
“Vanguard is aiming to make generating income from your target-date fund in retirement easier,” Jason Kephart, a senior principal at Morningstar, told me. “Including an annuity in a target-date fund will give people an easier opportunity to annuitize a part of their portfolio at retirement if that works with their retirement plan. They won’t have to deal with commissions or overly complex annuities.”
To annuitize essentially means to convert a lump sum portion of your employer retirement plan account into a guaranteed paycheck for a specified period or for the rest of your life.
The new offering could be a salve for a deep-seated retirement worry: running out of money if we live a long life, having high healthcare bills as we age, or seeing the markets drop and not bounce back quickly.
Participants will initially be enrolled into a Target Retirement Lifetime Income Trust, based on an expected retirement age of 65. While not technically called an account, the product is available in your employer’s 401(k) lineup of selections and will initially operate like a typical target-date fund.
With those funds, you choose the year you’d like to retire and buy a mutual fund with that year in its name (like Target 2044). The fund manager then divides your investment between stocks and bonds, typically made up of index funds, adjusting to a more conservative mix as the target date nears.
In Vanguard’s new product, at age 55, a portion of your fixed-income savings will be shifted to a TIAA secure income account, which is a type of fixed annuity (an insurance contract that provides a pension-like guarantee for growth and a lifetime income stream).
By age 65, the annuity portion will reach 25% of your account, and you can decide when to convert that portion into a paycheck. If you wait until you are 72, your account would consist of about 40% equities.
Much like other defined-contribution plans, if you leave an employer and change jobs or are laid off and hold the Target Retirement Lifetime Income Trust, you typically will be able to leave your funds in the plan, roll them over to an IRA, or cash out, according to a Vanguard spokesperson. “Specific options for what participants can do will be defined by the plan sponsor,” he said.
The retirement gap
Without question, there’s a savings gap that has upped the demand for this kind of traditional pension protection. Since 401(k)s became the predominant savings vehicle, largely replacing traditional pensions, retirement savers have borne most of the burden of building their own retirement savings accounts.
Roughly 6 in 10 Americans are not on track to be financially secure in retirement, according to Vanguard's recent Retirement Outlook report. Among workers aged 61 to 65, only the top 30% of income earners are ready for retirement.
Meantime, nearly half of employees say they’ll need more than $1 million saved to retire, according to a new survey from Betterment. Fewer than 3 in 10 expect they’ll actually have that much saved.
Vanguard is not the first to combine target-date funds with annuities. BlackRock’s LifePath Paycheck, for instance, launched in 2024. And no doubt, there will be more to come as these accounts begin to gain traction. The combination of an annuity and Social Security benefits could calm many retirees' concerns about monitoring their investments, deciding which ones to pull money out of for living costs, and stomaching market swings.
The hitch is that annuities sold by insurance companies have a bad connotation for many folks, and for good reason: They can be complex to understand and layered with fees. When you buy an annuity, you agree to hand over your savings to an insurance company, and it’s hard to get it back.
I asked several financial advisers and experts for their take on Vanguard’s new offering.
TIAA’s secure income account is a straightforward income annuity that will offer monthly payouts for life in exchange for a lump sum of money, Kephart said.
But then he backed up a few steps. “There’s still a big education gap … that will need to be addressed,” he said. “With embedded annuities, participants must understand how the income feature works, when to activate it, and how it fits into their overall retirement plan.”
That will take some legwork. “Regular target-date funds without an annuity are designed to grow wealth during working years and gradually reduce risk as retirement approaches, not to deliver a steady, predictable income in retirement,” he said. “The additional homework for investors runs counter to what has made target-date funds so popular — they require little effort.”
Target-date funds “addressed the problem of how people save for retirement,” Preston Cherry, a certified financial planner and president of Concurrent Financial Planning, told me. “They never really addressed how people live on that money once they retire.”
“One of the biggest gaps in the US retirement system is that we tell people how to accumulate, but we largely leave them on their own when it’s time to distribute. Retirement income planning is when the decisions actually get harder. This kind of fund could help reduce anxiety and improve confidence around spending in retirement and can provide income certainty,” Cherry said.
Steve Parrish, professor of practice and scholar in residence at The American College of Financial Services, said the new Vanguard product “can be a great ‘in betweener’ concept,” that offers “growth, yet guarantees.”
“The challenge is pricing and packaging. How can they price the annuity guarantees to coordinate with the target-date funds, and how will they be packaged so they work together? If it’s just a matter of allowing a target-date fund to be rolled into a single premium immediate annuity, this feels more like window dressing than anything new,” Parrish said.
'Complex, often irreversible decisions'
Perhaps the most important component: education.
“The moment guaranteed income products are packaged and delivered this way, more responsibility and potential liability shifts onto employers and plan sponsors, who are now expected to educate and guide employees on complex, often irreversible decisions,” Pam Krueger, founder and CEO of financial advisor referral service Wealthramp, told me.
“We need to know who, exactly, is responsible for explaining what these products truly cost, how liquid they are, what the penalties are, and what happens if circumstances change,” Krueger said.
Retirees need help making decisions on a wide range of financial moves: spending, taxes, Social Security, and more. No embedded solution can do that on its own.
“Guaranteed income can be useful; it may have a place. But without fiduciary advice, it risks becoming a default substitute for financial planning rather than a truly thoughtful choice,” Krueger said. “There’s too much at stake to not understand this.”
By Kerry Hannon · Senior Columnist
Kerry Hannon is a Senior Columnist at Yahoo Finance. She is a career and retirement strategist and the author of 14 books, including "Retirement Bites: A Gen X Guide to Securing Your Financial Future," "In Control at 50+: How to Succeed in the New World of Work," and "Never Too Old to Get Rich." Follow her on Bluesky and X.
