Three Considerations for Lifetime Income with Tax Reform 2.0

On September 27, 2018, the US House of Representatives approved H.R. 6757, Family Savings Act of 2018 as part of Tax Reform 2.0. Meanwhile, the Senate is anticipated to vote on the Retirement Enhancement and Savings Act (RESA), potentially setting up a conference on the two chambers’ retirement bills this Fall. Please read on for more details in this article by Ross Krinsky, SVP Fidelity Benefits Consulting.

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One area of divergence between these bills relates to lifetime income and the selection of annuities.

RESA has specific guidance regarding the disclosure of lifetime income stream equivalent of 401(k) accounts. The bill also provides a fiduciary safe harbor for plan sponsors in the selection of an insurer for a guaranteed retirement income contract.

The Family Savings Act, while similar to RESA in many ways, did not include the lifetime income disclosure requirements. Regardless of the ultimate outcome, these proposals highlight a growing interest in how our current 401(k)–centric retirement system handles the issue of Lifetime Income for plan participants. 

Defined contribution plan sponsors have generally taken a hands-off approach to the subject of annuities for their participants. Other than “Money Purchase” plans, there is no requirement for plans to offer participants an annuity option at retirement. But, future retirees will likely need more guaranteed income than will be provided by Social Security. Your participants are going to need more support converting their plan balances into guaranteed income, and the legislative trend is moving toward added responsibility for plan sponsors. 

Now is the time to start preparing a strategy in order to address these needs.

1. Take Basic First Steps

A good way to start is to familiarize yourself with annuities and the role they can play in retirement. Lifetime fixed Income annuities are among the most common income product retirees utilize. An income annuity is an insurance product. For a one-time cash payment from the customer (“annuitant”), the insurer provides a guaranteed fixed payment for the life of the annuitant. The payment will not change and the insurer’s obligation to make the payment will never expire.

A survivorship benefit can also be added so that, upon the death of the annuitant, a percent of the fixed payment continues for the life of the beneficiary. 

What a lifetime income annuity can do:

• Hedge against market swings
• Provide guaranteed income for life
• Help diversify your income sources

2. Assess the Current Participant Support

Many companies are focusing on the financial wellness and total wellbeing of their employees. This focus on well-being could extend to planning for successfully maintaining a standard of living in retirement.

Sponsors should review the current retirement planning tools and education available to your employees, including lifetime income. Assess the effectiveness of what is available and develop additional resources as needed.

3. Provide Easy Access to Annuity Products

The mechanics of purchasing an immediate income annuity using assets from a 401(k) plan is relatively straightforward. The actual purchase works just like a rollover to an Individual Retirement Account (IRA); money is rolled over to a tax-qualified annuity contract and there is no immediate taxable event. Payments from the annuity contract are then taxable in the same way withdrawals from an IRA are.

Some plan sponsors provide participant access to an annuity shopping service to help in the annuity purchase process. These services provide a fairly wide range of annuity options from a pre-selected group of insurers. Plan sponsors have found that these services can provide a helpful way for their employees to explore options without creating sponsor fiduciary risk; any resulting purchase is still an individual annuity from a 401(k) rollover. 

As mentioned, plans classified as money purchase plans must provide an annuity option to their participants. In these situations, the annuity is actually purchased by the plan on the participants’ behalf. 

From a legal perspective, these annuities are typically part of a group annuity contract between the plan and the insurer. Participants who elect an annuity are issued a group annuity certificate detailing their benefit. Group annuity pricing can be lower than the individual market as plan sponsors leverage their purchasing power to negotiate favorable pricing. However, plan sponsors have been reluctant to adopt this model for non-money purchase plans, primarily due to the ERISA and fiduciary risk involved. Once a plan sponsor takes an active role in the selection of annuity provider on behalf of its employees, they take on a fiduciary role and must also comply with certain ERISA requirements.

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Group annuity pricing can be lower than the individual market as plan sponsors leverage their purchasing power to negotiate favorable pricing.

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The language in both bills defining a safe harbor method of annuity selection is very similar to guidance issued in 2008. While the term “safe harbor” implies an objective standard, the guidance still contains a fair amount of subjective judgment since, among other things, it requires an “objective, thorough, and analytical search for the purpose of identifying insurers from which to purchase such contracts.” Subjectivity entails risk so it is perhaps not surprising that the 2008 guidance resulted in very few plans offering annuities. 

RESA contains similarly subjective language so, even if passed, this legislation is not expected to change plan sponsors’ minds on this topic. While the current legislative proposals reflect the intention to encourage lifetime income, the specifics of the proposals make it likely plan sponsors will wait before making any decision to provide annuities from the plan. 

For now, sponsors should focus on planning resources and “out of plan” annuity access made available to participants as they approach retirement.  

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Fidelity does not provide legal or tax advice, and the information provided is general in nature and should not be considered legal or tax advice. Consult an attorney, tax professional, or other advisor regarding your specific legal or tax situation.

Views expressed are as of the date indicated and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the author, and not necessarily those of Fidelity Investments.

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