One of the challenges that defined contribution (DC) plan participants face is how to turn their savings into income that will last through the end of their lives. Annuities can be good tools to help retirees manage the risk of outliving their savings – but DC plan participants usually do not annuitize their savings. Retirees who want to buy annuities generally must do so on their own as very few DC plans integrate annuity withdrawal options in their design. Within the last several months, however, the U.S. Department of the Treasury and Internal Revenue Service released two rules that may make annuities easier for some DC plan participants to access.
Prior to Treasury’s recent regulation, retirees were penalized for using 401(k)-plan or IRA assets to purchase a deferred life annuity, in which payments begin years after the annuity is purchased (for example, at age 80 or 85) and continue until the death of the policyholder. Generally, Americans over age 70 ½ with 401(k)-plan or IRA assets are required to withdraw a certain amount each year, called a required minimum distribution (RMD). Those who purchase immediate annuities, which start payments right away, are granted relief from these requirements; until recently, those who purchased deferred life annuities, also known as longevity insurance, were not granted relief from the RMD rules. Treasury’s regulation, released in July, ensures that deferred life annuities will qualify for the same RMD relief as an immediate annuity, removing a significant disincentive to the use of longevity insurance.
The second rule, which was finalized in October, eases requirements for DC plan sponsors that wish to include certain deferred annuities in their plans and utilize them as default options. Increasingly, DC plans include “target-date” funds that adjust from more aggressive to more conservative asset allocations as the participant approaches their target date for retirement. Some plan sponsors are interested in including target-date funds with deferred annuity components.
In general, any investment option that a DC plan offers must be available to all participants in the plan. Prior to these regulations, each target-date fund in a series was considered to be its own fund and therefore could not be restricted by age. As an example, a DC participant turning 67 in 2050 could choose to invest in a fund intended for someone turning 67 in 2040 or 2060. Because annuity rates depend on the policyholder’s expected lifespan, the insurance companies that write annuity contracts require that only individuals who fit the intended age range be allowed to purchase those products. In other words, a target-date fund for someone retiring in ten years that includes a deferred annuity would be mispriced for someone who is currently 35 years old.
The new rule clarifies that a target-date fund series as a whole may be considered one fund and therefore that the plan may include – or select as a default – a target-date fund that is partially composed of a deferred annuity and wherein particular series funds are limited to participants of the appropriate age.
The combination of these two rules may provide easier access to lifetime income for some DC plan participants, but more could be done. In particular, many plan sponsors are wary of offering annuities within the plan at all since they can be held liable if the insurer fails to make promised payments. Nonetheless, greater availability of lifetime income products could help more Americans achieve a secure retirement, and the new Treasury regulations are sensible steps towards that goal.
Alex Gold served as a policy analyst for BPC’s Economic Policy Project.