Government debuts lifetime income initiatives (cont.)
In my last column, I began a discussion about the package of
proposed regulations and immediately effective revenue rulings pertaining to
lifetime income, released by the Internal Revenue Service (IRS) on February 2.
In this column, I address the rest of the regulation and revenue rulings.
Educating participants and plan sponsors. Any effort to
educate participants as to how longevity annuities can hedge against outliving
their retirement assets will need to address not only the longevity risk but
also the long-term viability of the insurance companies providing the annuity.
Plan sponsors will also need to understand the added fiduciary exposure from
their selection of an annuity provider. Existing Department of Labor (DOL)
regulations consider the selection of an annuity provider a fiduciary act and
require plan fiduciaries to conduct an “objective, thorough and analytical
search for purposes of identifying providers from which to purchase annuities.”
A plan fiduciary may be required to hire a qualified independent expert, if the
fiduciary lacks the appropriate expertise to make the selection. Before adding
longevity annuities as a plan investment option, many plan sponsors may look for
a reaffirmation that implementing a prudent process in the selection of an
annuity provider will be sufficient to insulate them from fiduciary liability,
should the insurer become insolvent.
Split distributions. One aim of the proposed regulations is
to eliminate impediments confronting plans that wish to offer split
distribution options, such as an annuity or a lump sum. It is important to
avoid forcing participants to make an all-or-nothing choice when it comes to
these alternatives, because participants are reluctant to forgo the liquidity
represented by the current availability to take cash.
The current rules do not prohibit split distributions, but
they are complicated and can provide results that defy common sense. For
example, where an optional form of benefit consists of a partial lump sum and a
partial annuity, the current regulations under Section 417(e) of the Internal
Revenue Code (IRC) require the use of statutorily prescribed interest and
mortality factors for both portions. Accordingly, a plan would be unable to use
its regular conversion factors to calculate the partial annuity—this means that
the annuity portion of a distribution, split equally between the annuity and a
lump sum, could be significantly more or less than one-half of the total
annuity benefit. Under the proposed regulation, the statutorily prescribed
factors would need to determine only the portion of the distribution being paid
as a lump sum, thereby providing a more intuitive result.