It seems like everyone in the legislative and regulatory environment in Washington wants to see lifetime income solutions offered by retirement plan sponsors. Lifetime income solutions are currently available for plan participants but are not widely used due to fear of liability surrounding the lack of instruction and regulation. Recently the IRS and the DOL issued guidance about these lifetime income vehicles to show plan sponsors the appropriate way to choose annuity providers.
IRS Notice 2014-66 provides that, if certain conditions are satisfied, a series of Target Date Funds (TDFs) offered only to older participants satisfies nondiscrimination rules.
Here is an example of how lifetime income solutions might be offered in a plan:
ABC Company offers TDFs from a provider and these funds utilize target retirement years 2020, 2025, etc. The funds have a glide path that decreases equity exposure as the participant gets older. These funds are available to all participants in the plan. An additional series of age restricted TDFs are offered for those participants age 55 and older. The age 55+ TDFs hold unallocated deferred annuity contracts as a portion of its fixed income exposure. The annuity contracts are purchased from an insurance company that is independent of the TDF investment manager. When the participant reaches retirement age and the age restricted TDF is dissolved, each participant will receive an annuity contract that will pay a benefit over the participant’s lifetime, or joint lifetime, of the participant and his or her spouse. This type of option will help ensure that the participant does not outlive his or her retirement benefit.
In this example, you have, in effect, helped the participant make their 401(k) plan into a personal defined benefit plan.
More than likely, there will be extra fees for this type of annuity contract and the employer would need to follow a prudent procedure in selecting the annuity provider. This guidance will most likely push providers to create more solutions which should make pricing more competitive in the future. The DOL’s letter further describes the procedures that should be followed in selecting the annuity provider:
The fiduciary engages in an objective, thorough and analytical search for the purpose of identifying and selecting providers from whom to purchase annuities
Appropriately consider information sufficient to assess the ability of the annuity provider to make all future payments under the annuity contract
Appropriately consider the costs, including fees and commissions, of the annuity contract in relation to the benefits and administrative services to be provided
Be able to appropriately conclude that, at the time of the selection, the annuity provider is financially able to make all future payments under the annuity contract and the cost of the annuity contract is reasonable in relation to the benefits and service provided under the contract
If necessary, consult with an appropriate expert or experts for the purposes of meeting these exceptions
Even though these solutions are not currently extensively used, now is the time to start thinking about how they could be implemented in your plan.