Over the past 20 to 30 years, the American retirement system has shifted from defined benefit plans to defined contribution plans. Defined Benefit plans were based on the concept of providing individuals with guaranteed income for life, income they could not outlive. Defined Contribution plan sponsors have been reluctant to offer similar lifetime income options for concerns about liability in selecting an annuity product. This lack of access to lifetime income could result in retirees outliving their savings and being forced to rely on other sources of income in their later years. This will place a significant burden on America’s economy as these individuals look to children, friends, and the government for support.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law in December 2019 and contains provisions that seek to expand access to lifetime income within retirement plans. The Act seeks to educate individuals on the projected income they could receive from their retirement savings. It also has provisions that should encourage plan sponsors to offer in-plan annuity options by providing a safe harbor for the selection of an annuity provider, as well as expanded portability of the annuity contracts.
This first provision is focused on educating plan participants on the income stream they might expect if they annuitized their retirement savings. Plan sponsors will be required to provide this lifetime income illustration once a year. Many plan participants do not comprehend how much savings they need to fund their retirement and this monthly income illustration will provide an indication of whether they are on the right track. This does not require an individual to select a lifetime income stream but will provide an idea of what a successful drawdown strategy could provide.
The required disclosure will likely not be required until 2021. The effective date is 12 months after the Department of Labor (DOL) completes the following:
Several companies already provide some type of retirement projections on their statements. Additional guidance from the DOL will be required to understand if changes will be necessary to those projections to meet the new requirement.
The SECURE Act creates a safe harbor for plans that offer a lifetime income option within their plan. Without the safe harbor, employers have been reluctant to offer a lifetime income option due to concerns over liability if the company offering the annuity is unable to meet its payment obligations. Creating the safe harbor should alleviate these concerns and result in more plan participants including lifetime income options within their plan. Employers seeking coverage from the safe harbor must do three things:
Insurance companies can provide a disclosure that will allow the employer to meet the requirement of showing that the insurer can meet its financial obligations. This disclosure from the insurance company does not satisfy the requirement that the employer must conduct a search to identify insurers from whom to purchase the annuity. Perhaps more important, this disclosure also does not satisfy the requirement that the employer must consider the cost of the annuity product selected. Once the annuity product is selected, additional clarification will be needed related to the ongoing review of the cost of that product.
Practice Point: Some annuity providers have created the required disclosure and are sending it to plan sponsors that currently offer in-plan annuity options. It is important for sponsors to understand that receiving this disclosure only satisfies the requirement that they determine the insurance company is financially capable of meeting its obligations. Plan sponsors will still need to review and determine that the cost of the annuity being offered is reasonable relative to the benefits and features the product provides.
A final provision related to lifetime income will allow plan participants to take a qualified distribution of an annuity product that will no longer be maintained in the employer plan. In addition to the fiduciary concerns of offering annuities, there were also administrative constraints that prevented many employers from including these options in their plans. Many lifetime income products can only be recordkept by the company offering the product. This meant that if the employer elected to move to another recordkeeper, they would be forced to discontinue access to that product, which would negatively impact the participant. Alternatively, if they continued to offer the annuity product, they would now be forced to work with two recordkeepers for their plan.
The SECURE Act will allow for in-service distributions of annuity products within 90 days prior to the plan sponsor discontinuing the availability of that product. This will allow plan participants to preserve their savings in the annuity product while still allowing the plan sponsor the ability to move the plan to a new recordkeeper.
These changes will increase education and availability of lifetime income in retirement plans. This increased focus on drawdown strategies for defined contribution plans is critical as Americans increasingly rely on their defined contribution savings to fund their retirement.
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.
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