Upcoming legislation is expected to make it a lot easier for defined contribution retirement plan sponsors to add an annuity product to their mix of equity and fixed-income offerings, which in turn could make it easier for plan participants to solve the issue of longevity risk.
But there are some big requirements for plan sponsors and fiduciary advisors to minimize liability, and potentially a significant hit on rollover assets going to retirees’ advisors, as the annuity contract will stay with the plan sponsor, said Mary Kathryn Campion, founder and president of Champion Capital Research, a Houston-based independent fiduciary advisory and investment management firm.
“Fiduciary advisors have to carefully weigh the costs and benefits of transferring this fiduciary responsibility to third parties with the understanding that complete fiduciary risk mitigation or transfer, especially at the plan sponsor level, is not possible,” she said. “And it is the plan sponsor who ends up owning the annuity, not the participant or the insurance expert or the fiduciary advisor. The plan owns the annuity contract. The participant is the beneficiary.”
So whether an advisor is a fiduciary advisor to one of these plan sponsors or a planner with clients who might be interested in availing themselves of an “income for life” option in exchange for a chunk of their accumulated assets, the impact of SECURE 2.0 and the LIFE Act might bring some complications.
“Obviously the goal behind these two pieces of legislation is clearly to improve retirement savings and retirement security. Concerns about later-life income and spending flexibility are the most salient topics influencing this discussion now. So whether in-plan or out-of-plan, these can be truly remarkable agreements and contracts to help someone achieve lifetime income,” she said yesterday at a seminar on retirement income solutions, put on by Broadridge Financial Solutions.
“Participants are craving security. They want certainty, they want a guarantee that post-retirement they will be able to, at the very least, fund their current lifestyle,” co-presenter Tyler Kirkland, director of product sales for Broadridge, said. “They want to be able to enjoy retirement with peace of mind knowing that the bills are going to be covered, and they don’t run out of money they need to survive. These are not new concerns.”
In some ways, Campion said, the annuity option will make defined contribution plans more like the defined benefit plans of yore.
“Those entities out there that had defined benefit plans are the ones most interested in these annuity strategies because now we’re offering a defined benefit to the participants,” she said. “And many corporations that gave up defined benefit plans know the value of having a defined benefit option for their employees.”
Available to both ERISA-regulated 401(k) plans and non-ERISA 403(b) plans, the new rules under LIFE require fiduciaries to make sure each participant is provided notice in writing on the targeted or maximum amount of money that will be placed in the annuity. No more than 50% of any periodic payment or plan balance a participant has can be allocated to the annuity.
Some of the guaranteed-income products available include immediate annuities, deferred income annuities, qualified longevity annuity contracts and guaranteed lifetime withdrawal benefit.
“It’s important that we, fiduciary advisors, are very clear that while we’re offering annuities as lifetime income solutions in 401(k) plans, we recognize that they’re not securities, they’re not mutual funds. They are not regulated by the SEC. They’re not regulated by Finra. They’re insurance contracts that are regulated by each individual state in which they are originated,” Campion said. “While we’re offering them as investments, they’re not investments. They’re agreements with an insurance company to pay a fixed income for an asset that we’ve given them.”
Popular options, she said, include the single premium immediate annuity (SPIA), which is purchased with a lump sum distribution out of the 401(k) plan. It’s irrevocable, but can include inflation protection. And the fixed indexed annuity (FIA), which is often used when someone is saving for retirement, as opposed to the SPIA, which is more for people about to need the income right away.
When a fiduciary advisor is helping a plan sponsor with annuity-provider options, the vetting process is the same as it is with any other vendor, Campion said.
“So now we have another vendor in the mix and that’s the insurance agent or insurance expert, and we much thoughtfully select and monitor that new vendor,” she said. “It’s no different from hiring a mutual fund manager, even though we’re hiring an agent that’s offering a contract and not an investment.”
And in order for plan sponsors to have safe-harbor protection should they make the decision to add an annuity option to their 401(k), they have to follow some specific requirements, including evaluating the issuing strength and financial stability of the insurance company, confirming state licenses and assessing fees and expenses. For example, Campion said that in terms of issuing strength, an insurance company might have to be in the top 50th percentile relative to peers in that state. Or to show acceptable stability, that company has to have 10 years of financial audits.
“Whether you’re a discretionary or non-discretionary advisor, if you maintain a fiduciary relationship with your client, you’ll be expected to follow and document a selection process to understand and benchmark the underlying costs and performance of the annuity product,” she said.
The downside for advisors to retirees is that participants may not want to roll their money out of the plans when retirement arrives.
“They’re getting everything they need in the plan, albeit at some cost,” Campion said. “But they’re getting their lifetime income satisfied while keeping their money in the plan.”
And that, she continued, is what will make these in-plan annuity options so desirable. The financial industry has done a good job helping people save enough to live to 90, but not so much for after that, she said.
However, financial advisors can step up to help their clients in a way that could make an in-plan annuity moot, she said.
Strategies in 401(k) plans for participants nearing retirement typically tamp down on equity risk with a glide path mechanism to a model portfolio strategy. “But we haven’t solved the longevity risk problem—the risk that we might outlive our assets because we live too long in retirement—using traditional glide path solutions,” Campion said.
One solution, which would be out-of-plan, is to offer the newly retired participant a deferred indexed annuity. The person who has saved enough to get to 90 only has to insure to 105 or 110.
“These instruments are relatively inexpensive and are the exact offering one would need to solve for longevity risk, without impeding the growth or changing the growth trajectory of the traditional strategy,” she said.