Encouraging Lifetime Income in US DC Plans by Daniel A. Notto, AllianceBernstein
With the continuing shift from defined benefit (DB) plans to defined contribution (DC) plans, fewer Americans have the ability to enjoy guaranteed income for life. Now, federal regulators are trying to change that.
A growing number of employers are freezing or terminating their DB plans, turning instead to employer-sponsored 401(k)s and other plans to support workers in their retirement years. Participants who make meaningful contributions to a well-designed defined contribution (DC) plan over their working years can build up significant nest eggs for their retirement years. But unlike DB plans, most DC plans aren’t able to generate lifetime income for their participants.
Labor Department Rewrites the Rules
For several years, the US Department of Labor (DOL) and the Internal Revenue Service (IRS) have considered how to encourage more DC plan sponsors to incorporate lifetime income features. They’ve changed rules or proposed new ones, provided more clarity and eliminated regulatory obstacles that inhibited more widespread adoption of these features.
For example, the DOL issued a regulation in 2008 that outlined the steps plan sponsors could take to satisfy their fiduciary duties when choosing insurance companies to provide annuities that support lifetime income options for their plans. More recently, the DOL indicated plans to strengthen this annuity selection “safe harbor” to provide even more comfort to plan sponsors.
Making Longevity Annuities More Accessible
The IRS has played a role, too. Last year, the agency finalized rules that would make it easier to use longevity annuities in plans and individual retirement accounts (IRAs). With this type of annuity, a participant could use up $125,000 or 25% (whichever is less) of his or her aggregate plan and IRA balances to buy a deferred annuity contract.
That contract would start making lifetime payments to the participant no later than age 85. The money used to buy the annuity would be exempt from required minimum distribution rules, which ordinarily require a plan or IRA to start payments when participants turn 70 ½.
More Clarity on Integrating Lifetime Income
Both the IRS and DOL provided more guidance last October. They clarified rules for incorporating guaranteed lifetime income into a DC plan’s default investment, a strategy that some plan sponsors have implemented in recent years. The IRS ruled that a series of target-date funds that includes annuities only in funds designed for older participants—who are likely to be more highly compensated—doesn’t violate rules that forbid skewing a plan’s benefits, rights or features in favor of highly compensated employees.
At the same time, the DOL confirmed what most retirement plan professionals and plan sponsors believed: the department’s rules permit the use of annuities as components of a qualified default investment alternative (QDIA). If participants don’t select an investment option, the plan sponsor can direct that their plan accounts invest in a QDIA. Such a QDIA includes a target-date fund that incorporates annuities to provide an income stream for life. The DOL also noted that a plan sponsor could delegate the responsibility of selecting annuity providers to a qualified investment manager.
As a matter of public policy, promoting strategies that may help DC plan participants’ retirement savings provide income for life makes sense. We believe that lawmakers and regulators will continue exploring ways to make that happen. In the meantime, recent guidance from regulators should prompt more DC plan sponsors to seriously consider adding lifetime income options.
“Target date” in a fund’s name refers to the approximate year when a participant expects to retire and begin withdrawing from his or her account. Target-date funds gradually adjust their asset allocation, lowering risk as participants near retirement. Investments in target-date funds are not guaranteed against loss of principal at any time, and account values can be more or less than the original amount invested—including at the time of the fund’s target date. Also, investing in target-date funds does not guarantee sufficient income in retirement.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.
Daniel A. Notto is Senior Retirement Plan Counsel at AllianceBernstein.