What is a 401(k) Guaranteed Product?

You've probably heard that the only two guarantees in life are death and taxes—but with recent stock market volatility, many retirement plan participants would like to add three more items to that list of guarantees: preservation of principal (I can't lose what I contributed), investment return (I know how much my money will earn), and lifetime income (I can't outlive my investments).

The good news is that guaranteed products in 401(k) plans can provide preservation of principal, as well as a predictable return and an income stream at retirement that lasts a lifetime.

Guaranteed products come in many flavors, but they’re generally classified as stable value funds, money market funds, and insurance products. The common denominators of guaranteed products are that they are conservative investments that provide steady investment return with relatively little risk, as your principal is guaranteed. Of course, less risk means lower returns than other investment options, like stock funds, that are not guaranteed. 

There’s another old adage that says you should look before you leap; so, while the guarantees are attractive, participants need to understand the mechanics of a guaranteed option before they leap in with their retirement dollars.

Although the terms of each guaranteed option may differ, they generally work like this: the funds are invested in government and corporate bonds, and there’s usually an insurance element to guarantee the principal and a predetermined interest rate. In addition to a guaranteed interest rate, there will be a guaranteed minimum interest rate and a guaranteed period—though they may change. Before reaching the end of a guaranteed period, the guaranteed interest rate for the next guaranteed period will be communicated. In exchange for these guaranteed features, there are usually restrictions and limitations on transfers and liquidations—so what are the benefits of using one?

 

What are the benefits of a guaranteed option in a retirement plan?

The benefits of a guaranteed option in a retirement plan are numerous for retirement savers—and keep in mind, if you’re a business owner looking at offering a retirement plan, you’re participant #1 in your plan. As such, make sure you understand these three benefits of a 401(k) guaranteed income option:

Offers guaranteed returns

The ability to offer guaranteed returns in a market that generally offers no guarantees is obviously a huge benefit, and it’s likely one of the biggest reasons people choose to utilize these types of offerings.

Minimizes risk in market volatility

We mentioned earlier that guaranteed options don’t necessarily offer the same high returns that other investment portfolios may, and that conservative approach is a huge benefit for risk-adverse investors and those getting close to retirement age. Because of the conservative nature of these types of funds, they are not susceptible to market volatility, keeping overall losses to a participant’s total investment at a minimum and preserving retirement dollars—even when the market starts dropping.

Provides peace of mind

Mental well-being can be just as important as financial health in retirement, and running out of money during retirement is a top concern and cause of stress among many retirees. Luckily, a guaranteed option can go a long way in providing peace of mind that the dollars will be there for them at retirement.

 

Important things to know about a 401(k) guaranteed option

The plan sponsor and financial advisor on the plan (if there is one—and with this type of plan design, the more professionals involved, the better) need to know that choosing to offer a guaranteed option with a 401(k) plan should be approached as more than a short-term commitment.

Why?

The rules surrounding guaranteed options make getting out of them difficult and expensive for plan sponsors who choose to discontinue the offering. When this happens, early termination charges could apply, as well as restrictions limiting the transfer of funds to a specified percentage each year. As such, it’s important for employers to consider the advantages and disadvantages of offering such an arrangement with their advisor or other trusted financial professional before choosing to roll out the plan.

As is the case with any type of investment, it’s also important for savers to understand how the guaranteed option works before choosing to utilize it. There are some specific things retirement savers will need to know about guaranteed options—mostly related to equity washing and competing funds.

Essentially, if a participant wants to move their money from the guaranteed option to a competing fund, like a money market fund or short-term bond fund, the money cannot be moved unless it has been “washed” for a period of time in a non-competing fund. There also may be some special rules that come into play when there are competing funds within the same lineup—but what does that all mean?

Basically, it means that the retirement saver needs to be aware that they may have some restrictions on when they can move money taken out of the guaranteed option and where they can move it to.

Additionally, employees need to understand that there are certain plan features and benefits—like auto rebalancing, for example—that they may not be able to utilize when using a guaranteed income option with their retirement account.

Is a guaranteed option a good idea for everyone?

To be completely blunt, a guaranteed option is probably not going to be the right plan design for every employer or every retirement saver. As we mentioned earlier, the plan sponsor and participant both need to know what they’re doing as it relates to the offering—not to mention that, at least for the plan sponsor, a guaranteed option needs to be a long-term commitment.

Plus, guaranteed retirement accounts come with a slew of complicated rules regarding distributions, movement between funds, and terminating/transferring the contract that not every plan sponsor will understand. And if the plan sponsor is worried about low engagement with the plan or foresees a short-term life cycle for the plan, a guaranteed retirement plan may not be their best option.

Learn more about retirement plan options: 401(k) vs IRA

On the employee side, guaranteed options are great for the risk adverse or those worried about depreciation of their retirement dollars. However, savers who choose this option need to know that these types of arrangements can be quite difficult to understand and may be more expensive than other retirement savings options.

 

We recommend consulting with your advisor or other financial professional to determine if a 401(k) guaranteed income option makes sense for your individual circumstances and needs.

For more tips and resources on saving for retirement, visit our Retirement Saving Resource Center.