Proposed new rules aimed at giving 401(k) plan participants more options to invest in annuities providing a guaranteed lifetime income stream may prompt some plan sponsors to offer such investments. But the proposals laid out jointly by the Labor and Treasury departments on February 2 don’t go nearly far enough to persuade a majority to do so, experts say.
That’s so even though plan sponsors have more reason than ever to see that employees are adequately prepared for retirement. Since the economic collapse in 2008, many workers, fearful they will not have enough money to last through retirement, have put off plans to retire despite, in many cases, being past their most productive years.
The long economic downturn “has shown a spotlight on how limited defined-contribution plans [like 401(k)s] are in helping companies manage” age-related attrition, says Martha Tejera, who consults with plan sponsors and is among 15 advisers to the Institutional Retirement Income Council.
With defined-benefit pension plans, which are fast dwindling in number, companies could offer to sweeten the retirement pot for employees who agreed to retire within a set time window, Tejera notes. But existing 401(k) rules make it unappealing to do that for 401(k) participants, except at the few companies that offer both types of plans.
The government’s new rule proposals don’t directly address that issue, but rather seek to boost demand among 401(k) plan participants for guaranteed income products that could allow them to negotiate their way through retirement more easily.
According to results of an Aon Hewitt survey released in January, only 16% of plan sponsors offer such an option. And only about 1% of participants at those companies take advantage of the opportunity, Tejera says, even though for most an annuity would be “a better deal” than taking distributions directly from the plan balance upon retirement.
In its bid to change that behavior, the government’s plan has four components, two of which are most significant. One is a change in rules for calculating annuity payouts that could make plan sponsors more willing to offer the option to put part of one’s retirement savings into an annuity while taking the rest in cash. That should appeal to new retirees reluctant to give up control of all their retirement savings and to those who simply find annuities hard to understand.
The other key proposal would make it easier for plan sponsors to offer “longevity” annuities. Such products offer participants the chance to defer up to 25% of their account balances into an annuity that starts paying out further into retirement, such as at age 80 or 85. Plan participants may be more likely to want such an option — and hence plans would be more likely to offer it — because the value of the annuity would no longer count in determining the required minimum distributions they must begin taking at age 70.
But retirement-plan experts view the proposed measures as baby steps that do not address the most important factors keeping plan sponsors from offering guaranteed retirement income products.
First, there are several potential liability issues. For example, while quite a few insurance companies offer such products — including several launched within the past year — each offers only its own solution. That undermines a plan sponsor’s fiduciary duty to prudently select investment options.
“You’re supposed to compare several different options for things like performance, appropriateness, and cost,” says Gregory Marsh, vice president and corporate retirement plan consultant at Bridgehaven Financial Advisors. “But if your provider offers only one solution, how can you actually make a prudent decision? Providers are going after clients, saying theirs is the greatest thing since sliced bread. But they have no fiduciary liability whatsoever.”
The plan sponsor also has a duty to pick an insurance company that will be able to make annuity payments for all of plan participants’ retirement years. “You’ve got to pick a provider that’s going to be around for 50 or more years,” says Robyn Credico, director of defined-contribution consulting at Towers Watson. “But many insurance companies have financial challenges and took bailout money, so employers are pretty reluctant to take that step.”
Or what if a plan sponsor tells a participant that, based on what the person has saved, he or she will get $500 a month from a retirement annuity — but ultimately he or she gets only $300? Could the plan sponsor be liable? The answer is not yet clear, says Tejera.
Second is the issue of plan portability. A plan sponsor that wishes to select a different plan provider can’t move the existing plan assets away from the incumbent provider, so participants will not get consolidated statements. That could be problematic, says Marsh.
For example, was the participant aware at the time of purchase that the guaranteed income product could transfer to a new provider down the road? If not, some participants may be upset about having their money in multiple places.
Also, switching providers could cause more administrative burden for the plan sponsor. Both sets of assets would be subject to discrimination testing to make sure highly paid employees don’t control a disproportionate share of plan assets, and both would be subject to IRS reporting.
“We’re really in the infancy of the whole process” of reforming the rules to help people be better able to afford retirement, says Marsh. “The proposed rule changes are a good thing, but the marketplace still has a lot to iron out.”