Defined benefit annuity: The next great innovation

Sometimes fate intervenes to give people what they deserve. I believe that after having their retirement security taken from them, Americans deserve more guaranteed income. It’s time to bring back the defined benefit pension — in a new way.

Here is an innovation that accelerates the growth of annuities without cannibalizing other products. Instead, this strategy expands the market, ensuring that all parties benefit. There are two key markets in which annuities will gain greater prominence: the 401(k) system and individual annuity sales.

From dominance to decline

In the 1960s and 1970s, insurance companies were the dominant custodians of Americans’ pension assets, primarily managing them through group annuity contracts. Leading insurers such as Metropolitan Life, Prudential, Equitable Life and New York Life played a central role in securing retirees’ financial futures. At the time, 62% of private-sector workers benefited from the financial security of a guaranteed pension, with major corporations such as General Motors, AT&T and IBM covering millions of employees through defined benefit plans.

By the 1980s, however, a seismic shift had occurred. The rise of 401(k) plans and the decline of employer-sponsored pensions drastically altered the retirement landscape. Since then, the U.S. has lost 56,000 defined benefit plans — equivalent to losing one pension plan for every resident of Carson City, Nev., or Cedar Rapids, Iowa. What followed was a catastrophe for American workers but a boon for asset managers such as Vanguard, Fidelity and BlackRock.

Some may argue that 401(k) assets still belong to workers, so this shift shouldn’t be seen as a loss. But that’s the wrong perspective. Wealth does not create a retirement standard of living — income does. Nobel Prize-winning economist Robert C. Merton highlights this critical distinction: While 401(k) plans focus on and report only account balances, defined benefit pensions and Social Security emphasize and report income — the real measure of retirement security.

Income, not wealth

Imagine a woman named Jane who retired in 2000 with $1 million in savings. At the time, she could safely earn $5,800 per month in interest from certificates of deposit. By 2020, that same $1 million provided Jane an income of just $75 per month — a 98% drop in income, despite her wealth remaining unchanged. This stark reality underscores why income — not account balances — should be the true measure of retirement security.

So how will insurers and annuities rise in prominence — without hurting asset managers?

Scenario No. 1: 401(k) plans

Imagine a solution that strengthens the business of asset managers while elevating insurers. This begins by recognizing that the 401(k) system is here to stay. The challenge is transforming it to function more like a defined benefit pension plan.

The current attempts to integrate annuities directly into 401(k)s are laudable, but they have gained little traction. Plansponsor has described how most plan sponsors lack “annuity fluency.” 

According to research from TIAA, “63% of plan sponsors surveyed said they are unable to articulate the value and importance of annuities.” This is a sad reality considering that, according to LIMRA, most 401(k) plan participants want guaranteed retirement income. Annuities will once again become preeminent, serving as the logical endpoint of a vast amount of 401(k) assets. This means an entirely new strategy for IRA rollovers and conversion of assets into annuitized income. 

A new defined benefit strategy driven by technology

A major appeal of this new defined benefit strategy is that it makes 401(k) plans resemble pensions without requiring structural changes to the 401(k) itself. This is achieved by wrapping the participant’s account in technology that transforms it into a funding vehicle for a personal defined benefit pension.

An individual creates a personal defined benefit plan by making five key decisions:

1. Choosing the age at which income payments begin.

2. Selecting the number of years to invest.

3. Choosing a payment option at retirement.

4. Setting a baseline growth assumption.

5. Defining the target annual retirement income.

For example, consider Maryann, age 35, who defines her plan as follows:

» Target annual retirement income: $100,000.

» Income begins at age 65.

» 30-year contribution period (ages 35-64).

» Life-only payout.

» 5% baseline growth assumption.

Using these parameters, the application calculates that Maryann must invest $1,500 per month to accumulate enough capital to purchase an annuity guaranteeing $100,000 in lifetime income.

Because investment performance is unpredictable, the system recalculates her required contributions annually to keep her on track. If performance falls short, she receives an annual report advising her to increase contributions. If returns exceed expectations, her required contribution decreases or she may choose to aim for a higher income. This process continues dynamically until retirement, when her account seamlessly converts into guaranteed lifetime income.

Transparency and investor empowerment

This continuous performance monitoring and real-time guidance introduce a new era of transparency and investor empowerment. This innovation doesn’t only establish a personal defined benefit pension — it transforms the 401(k) ownership experience, shifting from static asset accumulation to active, outcome-driven financial planning.

What about inflation?

Focusing on income naturally leads to education about inflation’s impact. Through video-based content and interactive modeling tools, participants can visualize how inflation erodes purchasing power over time. For example, Maryann might realize that her $100,000 target should actually be $200,000 in order to maintain her lifestyle. This insight incentivizes her to increase contributions, creating a win-win-win scenario for clients, employers and recordkeepers.

Scenario No. 2: The individual annuity market

Get ready for the term “defined benefit annuity.” This concept is poised to become a sought-after business opportunity.

Imagine giving a client without a pension the gift of a personal pension plan. How many of your private-sector clients and prospects currently participate in a defined benefit pension? Few. But you can change that. You can put every client on the path to a more financially secure retirement.

With a defined benefit annuity, agents can now offer a fixed indexed annuity that is more relevant, valuable and timely than ever. It’s a powerful new way to connect with clients, differentiate from competitors and generate referrals. As described previously, clients design their own pensions, making the conversation more personal and impactful than a typical product pitch.

The technology behind the defined benefit annuity

The defined benefit annuity system is not a one-and-done transaction. It’s a continuing financial ecosystem where clients log in to view reports, communicate with agents and model the impact of inflation. By simplifying the retirement planning process and providing actionable insights, the defined benefit annuity empowers clients to take control of their financial future while fostering stronger collaboration with their agents.

In 1995, the first fixed indexed annuity launched a revolution in product design. Now, 30 years later, the fixed indexed annuity is about to be launched again, becoming a true strategic answer for retirement security. 

David Macchia, MBA, RMA, CBBF, is founder, Wealth2k. Contact him at [email protected].