It’s well documented that over the last several decades, employers have slowly migrated away from traditional defined benefit retirement plans in favor of the more financially consistent and less burdensome cost structure associated with defined contribution retirement plans. With this shift in the retirement landscape, participants have seen fade the guarantee of a lifetime benefit. When the financial crisis of 2008 created a shock to the account balances of defined contribution plan participants near retirement age, many retirees faced the reality of outliving their account balances.

Since the crisis, participants have expressed a desire to better understand what stream of income they will have during retirement and if it will last through their lifetime. The U.S. government began asking the same question. In 2010, the Department of the Treasury, the Internal Revenue Service and the Department of Labor issued a request for information on a variety of issues focused on understanding and increasing the use of lifetime income options in defined contribution plans.

After reviewing comments from a variety of retirement industry organizations and providers, the government began taking action. Shortly after the request, the president’s Council of Economic Advisers issued the report “Supporting Retirement for American Families.” It highlighted the risks facing workers from increased reliance on defined contribution plans and longer life expectancies and laid out the role that regulatory guidance might play in dealing with these risks.

Retirement plan providers also began to take notice of participants’ expressed desire for a guaranteed stream of income during retirement. Over the course of the last several years, multiple products have been brought to market by these providers with the goal of providing a steady stream of income, most notably many guaranteed minimum withdrawal benefit products.

Intuitively, products that provide a stream of income should be interesting to plan participants. In particular, those persons who have lived through the volatility of the past 10 years might find it appealing to lock in some portion of their nest egg to provide an income stream in retirement. Disappointingly, however, many of these products are less than ideal, and adoption by plan sponsors and plan participants has been minimal.

More recently, regulators have been active in releasing guidance to actively pave the way for income-producing products to be included within defined contribution plans. During 2014, the Treasury Department issued final rules on longevity annuities, which are aimed at bringing more flexibility to retirement savers using the fixed-income vehicles as a longevity hedge. In addition, Treasury and the Internal Revenue Service issued guidance on the use of annuities in target-date funds.

Treasury officials state that the final July 2014 rules on longevity annuities ease certain minimum distribution requirements that have made it difficult for retirees to purchase and hold longevity annuity products. A longevity annuity is a type of deferred income annuity that begins payments when a retiree is at an advanced age, say 80 or 85. Once payments commence, the income stream continues throughout the purchaser’s lifetime. The products can provide a cost-effective solution for retirees willing to use part of their savings to protect against the possibility of outliving the rest of their assets. In addition, longevity annuities can help retirees avoid the alternative prospect of limiting spending too much in retirement.

It is notable that this newfound focus from the regulatory bodies on promoting annuities is a shift from a multiple-year trend in the retirement industry to move away from annuity-type investments. Historically, many defined contribution plans had utilized annuities as the investment structure for the products offered in the plans’ investment menus. Most of this usage had been driven by the insurance companies that provide plan record-keeping and administrative services to employers and their retirement programs. Over time, employers and their plan advisors or consultants came to realize this annuity structure in many cases added to plan costs and complexity. 

The new ruling makes it clear that the federal government wants to make it easier for defined contribution plan participants to buy annuities to lock in a guaranteed income for life. The ruling is also an early sign that the government is seeing the upside to annuities, possibly because they could relieve the pressure on government entitlement programs to provide retirement income. By providing access to products with institutional pricing, plan sponsors can significantly increase the amount of retirement income that participants might receive. Research is showing that some retirees may be served best by choosing a combination of retirement income and other plan payments. Additionally, plan sponsors can help overcome inertia by facilitating the implementation of employees’ decisions.

However, fiduciary standards appear to pose a meaningful obstacle to widespread annuity adoption in defined contribution plans. Only a minority of sponsors are likely to be willing to undertake the due diligence required to select and monitor an annuity provider—or hire an independent expert to do so. Given the fiduciary requirements, as well as low take-up rates by participants, annuity options seem unlikely to soon become the primary source of retirement income for defined contribution plan participants.

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