Annuities in 401k plans?
Not a common occurrence to date. The “last mile,” some call it.
In fact, while companies already can offer annuities in their 401k lineups, just 9% do, according to the Plan Sponsor Council of America.
The primary reason holding plan sponsors back—fear of legal liability if the annuity provider fails or otherwise fails to deliver—could very well be gone if the latest retirement reform legislation becomes law.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act stuck in the Senate as of press time (but quite possibly tacked on to a must-pass appropriations bill in the interim) contains a key provision that removes that liability fear from plan sponsors. It could kick open the door to a 401k-plan market long coveted by life insurance companies that provide annuity products.
Specifically, the SECURE Act’s “safe harbor” provision (Section 204) would allow plan sponsors to select insurers to provide guaranteed income solutions, and then protect those sponsors from liability should participants or their beneficiaries suffer losses if the annuity provider ends up going out of business, defrauds employers or is otherwise unable to satisfy its financial obligations under the contract terms.
The SECURE Act would also make annuities inside 401k plans portable, so workers who leave their jobs could roll them into another plan or IRA without incurring surrender charges and other fees.
While plan sponsors have traditionally focused on helping participants to make appropriate decisions about investing their assets, there hasn’t been much effort put into helping make sure their retirement savings lasts a lifetime once they’ve accumulated significant account balances.
Both the safe harbor and portability provisions are seen as significant steps toward remedying the situation.
So the million-dollar question (billion-dollar question?) is, once plan sponsors have that safe harbor, will they indeed embrace annuity products within their 401k plans?
They will if the government and the insurance industry have anything to say about it. And they have already said plenty.
There’s been a push from government for years to provide seniors with access to guaranteed income streams in the face of long-declining access to pensions, increasing longevity and a general population that has not exactly excelled at saving for retirement.
In 2014, the Treasury Department issued rules meant to promote the use of longevity annuities in 401k plans as part of a push for access to guaranteed income streams to combat the declining pension and longevity issues.
The Treasury also approved the use of annuities in target-date funds in 401k plans in 2014, even when that fund is a plan’s default investment option.
Those actions haven’t moved the needle much, and annuity usage in 401k plans remains stubbornly low. A recent Willis Towers Watson survey found that while 30% of 401k plan sponsors offer some sort of lifetime income solution for participants, the vast majority of them don’t use annuities specifically.
In fact, 88% offer systematic withdrawals. Only 17% offer funds (such as a TDF) with a built-in annuity component and 15% offer a deferred annuity as a stand-alone investment option. Beyond that, 15% use a third-party platform to provide participants with an out-of-plan annuity.
The WTW survey found the use of lifetime income options has increased by seven percentage points in the three years since the survey was last conducted, but the overwhelming majority of that gain appears to be from noninsurance options.
That could change with the provisions in the SECURE Act as legislators, with a push from the insurance industry, take another shot.
Plan participants keeping an open mind
Regardless of whether plan sponsors, annuity providers and government make it easier for plan participants to include annuities in their 401k plans, that needle won’t move unless participants overcome old biases and buy into the concept.
With pensions now available to only about 17% of private-sector workers, Social Security only covering about 60% of pre-retirement income and huge numbers of Americans stressing about their retirement savings, the appetite just might be there.
Preventing people from “running out of money” has long been a primary selling point for annuities, and there are plenty of people for whom that fear is very real.
Almost half of Americans—49%—cite running out of money as their chief retirement concern according to a 2019 report from the Aegon Center for Longevity, Transamerica Center for Retirement Studies and Instituto de Longevidade Mongeral Aegon (Brazil).
Another recent survey by the American Institute of Certified Public Accountants also found running out of money to be the No. 1 financial concern among people planning for retirement.
Jean Statler, executive director of the Alliance for Lifetime Income (and incidentally the exclusive sponsor of last summer’s Rolling Stones U.S. tour!?!) points to surveys showing Americans want choice and greater access to annuities.
Seventy-three percent of respondents say guaranteed lifetime income is highly important to their financial security, according to a 2018 Greenwald/Cannex study. And a 2018 LIMRA Secure Retirement Institute study found that nearly seven-in-10 retirees who own an annuity are more confident their savings and investments will not run out if they live to age 90.
“There’s a reason that annuities are popular and have been vitally important to peoples’ lives for hundreds of years. They’re the only product that has protected retirement for millions of Americans, giving them a source of guaranteed income they can count on for life,” Statler stated in a September op-ed on 401kSpecialist.com.
Is “Safe Harbor” provision safe enough?
Not everyone thinks the SECURE Act’s safe harbor provision goes far enough to protect plan participants.
Section 204 says the safe harbor applies as long as the insurance company is licensed by a state for seven years; it does not assess whether the company is financially secure or highly rated by credit rating agencies.
Critics point out this means it would cover even insurers that are rated below investment grade and that barely meet pass-fail standards of state insurance departments.
There is no requirement for the plan sponsor to select the lowest-cost contract when selecting an annuity provider.
The safe harbor provision was the subject of a July 24 policy brief, “Reducing regulatory obstacles to annuities in 401k plans,” by J. Mark Iwry, nonresident senior fellow in Economic Studies at Brookings and Visiting Scholar at the Wharton School, along with Brookings’ William Gale, David John, and Victoria Johnson.
“We recommend mitigating the risk of liability by enacting an appropriate statutory fiduciary safe harbor for DC plan fiduciaries who select annuity providers that are highly qualified (highly rated for financial strength),” the brief states. “The pending legislative version, however, has no financial strength standard. It does not even favor financially stronger providers; instead, it grants the same stamp of approval to virtually any annuity provider that has been licensed to do business for seven years.”
The authors recommend a safe harbor that would be unambiguously limited to selection f the annuity provider based on its financial strength and stability; it would not apply to fiduciaries’ decisions regarding the type, price, or other terms of annuity contracts. Those decisions would continue to be subject to ERISA’s regular fiduciary standards.
Editor’s Note: Since publication, Jack Dolan, Vice President of Public Affairs at the American Council of Life Insurers, offered the following response to the Brookings policy brief:
“Their claim of a ‘no financial strength standard’ in the bill is bogus. It is a comment that ignores the solvency standards of the state-based regulatory system. Any annuity provider selected by an employer would have to be well capitalized by state (NAIC) standards. That’s a high bar,” Dolan said.
Calling the policy brief’s criticism “misguided,” Dolan offers further explanation in a post he wrote Aug. 14.
The Consumer Federation of America has complained that the legislation’s language is too broad and may allow for the inclusion of high-cost annuities. “The provision doesn’t apply to a narrow segment of annuities. It applies to all annuities. Some are consumer-friendly, but there are other types that are complex with high costs and are not in the consumer’s best interest,” Hauptman said in a late-June Barron’s article.
CFA, along with the Center for Economic Justice, sent a letter to the Senate seeking to change some of the annuity provision language. It includes recommendations to revise the definition to include only “simple fixed annuities’’ and not variable and fixed indexed annuities, and to add a requirement for employers to review insurers’ financial strength ratings.
An “ad” for annuities?
One more notable provision of the SECURE Act, which critics say amounts to an advertisement for annuities, is that plan sponsors would be required to provide a “lifetime income disclosure” that would project how much money a person might receive if he or she moved all their 401k assets into an annuity (plus legal protection for employers if those projections prove to be overly optimistic).
Chuck DiVencenzo, president and CEO of the National Association for Fixed Annuities (NAFA) in Washington, D.C., says the provision would indeed help 401k plan participants understand what their current account balance, saving patterns and investments might provide as a monthly income stream during retirement.
Noting that the bill does not require any employer to offer annuities within their retirement plan, he said in an op-ed in the Knoxville News Sentinel this summer that “the legislation would help consumers understand the risks of saving too little during their accumulation phase in an effort to secure a stable retirement income for their lifetime.”
Many remain critical of the idea of using annuities in defined contribution plans, pointing to their complexity and high fees. Barbara Roper, director of investor protection at the Consumer Federation of America, wrote in an op-ed in The New York Times, “There will come a time where we will point back to this as the start of a trend toward high-cost annuities being offered in 401k plans to the detriment of retirement savers.”
Whether more annuities in retirement plans ends up being a good thing or bad thing remains to be seen. But with the SECURE Act adding the gas to power annuities down that “last mile” to the metropolis of 401k plans, we may now find out sooner rather than later.
Brian Anderson is the Managing Editor of 401k Specialist. You can reach him at banderson@401kspecialist.com.