Employees willingly would give up a percentage of their salary for a guaranteed source of income during retirement, according to Bank of America Merrill Lynch data. The firm's 2012 Workplace Benefits Report found that 82% of employees reported they would give up 5% or more of their salary for a reliable income during their later years; 42% said they'd be willing to give up 10% or more of their salary. With Americans living longer and uncertainty lingering in the investment marketplace, retirement plan participants may consider guaranteed-income products to protect them financially in their golden years.
However, many of these options - such as longevity annuities and managed payout funds - are extremely rare options in employer-sponsored DC plans due to fiduciary and administrative complexities.
Longevity annuities are insurance products that offer participants the chance to defer portions of their account balances into an annuity that begins regular payouts later in life, usually age 80 or 85. Yet, only 16% of employer-based retirement plans currently offer "in-plan" lifetime income solutions like longevity annuities or managed payout funds, according to an Aon Hewitt survey.
More plan sponsors may include longevity annuities, or products with similar goals, in their plans if new regulations are drafted to support their concerns and employees start demanding guaranteed-income options.
Currently, 401(k) and IRA participants need to start taking minimum distributions from their account by 701/2 years old. Because longevity annuities don't begin paying out until much later, a disconnect arises. If participants don't have enough money in their account because capital went toward an annuity premium, they often can't take the minimum distribution from the account.
The Treasury Department and Internal Revenue Service have proposed regulations to waive minimum distribution requirements for participants with money used to purchase a longevity annuity, if certain thresholds are met. Once proposed regulations are finalized and the minimum distribution issue is addressed, experts predict that longevity annuities will be used more in the IRA market.
The IRS has proposed that Qualified Longevity Annuity Contracts allow individuals to purchase a longevity annuity from an IRA - or, less commonly, 401(k) - under a 25% or $100,000 limitation, whichever is less, without causing problems under the minimum distribution rules. In other words, investors could purchase more than the limitation but the minimum distribution requirements would still apply.
The American Benefits Council has recommended the IRS create a correction program for unintentional errors, similar to the Employee Plans Compliance Resolution System. The benefit advocacy group also suggested that IRS and Treasury facilitate the purchase of QLACs outside of a plan without leakage. This means individuals wouldn't need to roll out their entire fund balance to buy the longevity, but rather subtract 25% or $100,000 toward an annuity premium, leaving the rest of the fund intact.
The products have a congressional advocate in Rep. Robert Andrews (D-N.J.). "Life expectancy is growing for so many people," Andrews says. "More people need to think about a guaranteed income beyond 85 years of age, so I think [longevity annuities] have value, but again I think it has value in a voluntary marketplace."
He insists the products should be coupled with "some kind of insurance fund paid for by the offerers of the annuity product that insures the buyer of that annuity against that risk," and that longevity annuities should be purchased through an insurance system that guarantees payment if something happens to the annuity offerer, thus protecting 401(k) sponsors and participants.
Still, he says, "I think that every person who has a defined contribution plan should have the option of putting his or her money in a guaranteed-income product. I think of it as an option to convert your defined contribution plan into a defined benefit plan if you choose to do so."
Andrews drafted legislation to allow greater access to guaranteed income options when Democrats were the majority in the House. Although the measure now has been tabled in favor of other congressional initiatives, he considers this issue "a long-term project for me and something I think shouldn't be partisan. I think Democrats and Republicans could actually agree on this, and it is something I'm going to pursue."
However, even if the legal aspects change, principle concerns remain for plan sponsors before many would consider adding a longevity annuity option to their 401(k) plans.
"There are administrative challenges, because there is still the fiduciary responsibility to review the insurance company, and then there's convincing participants to actually use it. So while we may think it's a good idea, there are still challenges to overcome," says Robyn Credico, defined contribution practice leader for North America at Towers Watson.
Massaro of Vanguard argues that from a financial planning standpoint, the idea of longevity annuities is appealing because "it's a direct way of hedging longevity risk, and upfront premiums for longevity insurance are much lower than those for immediate annuities. This makes them more palatable because retirees are generally more reluctant to part with huge chunks of their savings," but acknowledges that "within a DC plan they are bit problematic."
Currently, adding longevity annuities in a 401(k) plan creates an additional fiduciary burden for the plan sponsor to determine whether money will be there when employees need it. This problem relates to all annuities and guaranteed-income products in DC plans.
"A plan sponsor would need to select and monitor an insurance company and do their due diligence to determine whether the insurance company would be able to make payments [well into] the future. That's an additional responsibility that most plan sponsors hesitate to take," explains Massaro. Sponsors would need to determine that the insurer could make payments 20 to 30 years in the future, depending when individual payout begins.
Causing additional concern is that many longevity annuities aren't liquid, so participants can't take funds with them if they change plans, and if they remove money early, they have already paid for insurance they won't see benefits from. Also, many don't include spousal or survivor benefits, so if the participant dies before they can collect payouts, their spouse does not receive a premium refund or the payouts.
Detractor calls products 'a gigantic scam'
Even if sponsors could feasibly add these annuities in a 401(k) plan, Jane White, president, Retirement Solutions, LLC, believes the very concept is at best unnecessary, and at worst, a scam. She believes if sponsors educate employees about secure withdrawal practices once they reach retirement, longevity annuity products are pointless. Before baby boomers decide to retire, for example, they should have a minimum of 10 times final pay to ensure sufficient savings for retirement.
"You can just take your nest egg, if you're lucky enough to have an adequate one, and withdraw 4% a year, and you won't run out of money. So, why are people making commissions selling [investors] products they don't even need?" she asks.
According to White, the vast majority of Americans will need to stay in the workforce for at least an additional decade longer than planned before they can afford to retire. For the minority that can afford to leave their job, responsible withdrawal strategies will sustain them. Says White: "I think [longevity annuity products are] a gigantic scam. Even if it weren't a rip off, you could just do it yourself."
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