Annuities in DC Plans

Creating a retirement income stream from savings is, in many ways, the most complicated part of working with one’s retirement plan. Studies have shown that people like the idea of a steady income stream but are unaware of the products—specifically annuities that they can purchase to help them attain that. As plan sponsors consider their options to give plan participants access to annuities through the company plan, advisers are in a position to explain the “how”s and “why”s.

Tim Brown, senior vice president and head of life and income funding solutions with MetLife’s retirement and income solutions group in Bridgewater, New Jersey, says advisers who can communicate how to convert accumulated retirement savings into a lifetime income strategy or draw-down strategy add great value to their business with plan sponsors and participants.

According to Brown, plan advisers, plan sponsors and providers recognize that defined contribution (DC) plans need to be not only a savings plan, but an income source for retirement. MetLife’s Lifetime Income Poll of DC plan sponsors last fall found 85% are beginning to recognize this.

Offering an annuity makes a defined contribution plan more closely resemble a defined benefit (DB) plan—an adjustment the government has been urging since passage of the Pension Protection Act of 2006 (PPA), says Glenn Dial, head of retirement strategy at Allianz Global Investors in New York City. Regulators have issued guidelines for including annuities in target-date funds (TDFs) and for allowing participants to use a portion of their plan balance to purchase qualified longevity annuity contracts (QLACs).

“DC plans have many investment options for accumulating assets for retirement, but there are few options for spending down assets in retirement,” Dial notes. “Annuities are part of the answer, and being able to offer advice about how to pick the right option will be crucial because choosing a decumulation strategy is much harder” than selecting an investment.

Yet, to date, DC plan sponsors have been reluctant to offer annuities in their plans, primarily because they fear fiduciary liability, sources say. However, a regulation issued by the Department of Labor (DOL) in 2008 regarding the selection and monitoring of annuity providers and annuity contracts under DC plans provides plan fiduciaries with safe harbor conditions. In addition, in Field Assistance Bulletin (FAB) 2015-02, the DOL answered questions it had received about the annuity selection safe harbor regulation for DC plans.

Brown says most plan sponsors believe the safe harbor needs to be strengthened, but insurance carriers have strict state regulations, and part of the DOL’s guidance is to allow plan sponsors to rely on state audits and regulations for appropriateness and strength of carriers. Plan sponsors had thought they needed to be certain the annuity provider would be around in 30 years to make good on the annuity payments, but the new bulletin says a sponsor need only determine whether the provider is financially viable at the time of the selection.

Brown suggests it would be helpful for advisers to educate plan sponsors about the risks participants face when it comes to retirement income. He points out that, according to the Society of Actuaries, 65% of Americans now age 65 will live to 85, and 25% will live to 95, with some surpassing 100. According to MetLife’s Paycheck or Pot of Gold Study, one in five retirement plan participants who selected a lump sum from either a DB or DC plan (21%) have since depleted it. Those who depleted their lump sums ran through their money in, on average, 5.5 years.

“Think about the popularity of TDFs,” Brown says. “Many participants view them as set-it-and-forget-it investments. When they shift into retirement, one thing an annuity can provide is a set-it-and-forget-it type of draw-down strategy.” The potential for a participant’s cognitive decline is another reason for a set-it-and-forget-it strategy, he adds.

Annuities are often framed inappropriately as investments, according to Brown, but they are insurance. “People don’t look at their auto or homeowner’s insurance and say, ‘Well I should get a return on my premium.’ The return is protection. Advisers using the term ‘protection’ will help plan sponsors and participants take the right actions,” he says.

Best Options Available
Sri Reddy, senior vice president and head of full service investments at Prudential Retirement in Hartford, Connecticut, says if plan advisers want to become knowledgeable about annuity and other lifetime income options, the Insured Retirement Institute (IRI) is a useful resource. Advisers can also do research online, attend conferences and rely on product providers, as those offer a plethora of information on their own and comparative products.

Some lifetime income products include:

• Immediate fixed-income annuities, which start pay-ments upon a participant’s retirement;
• QLACS, which are income annuities that start on or before age 85 to protect against running out of money if a participant lives longer than he expected;
• Guaranteed lifetime minimum benefits (GLMBs) and guaranteed lifetime withdrawal benefits (GLWBs), which, Reddy says, combine an annuity structure with potential market upside and more control for participants;
• Managed payout funds and managed account products, which offer income payments, but are not guaranteed as annuities are.

According to MetLife information, options also include guaranteed lifetime withdrawal benefits (GLWBs). MetLife explains that guaranteed minimum withdrawal benefits (GMWBs) and GLWBs provide income flexibility and guarantees at an additional expense. Further, plan sponsors may offer a systematic withdrawal plan (SWiP) as a distribution option for participants; this option provides full flexibility but no guarantees—thereby exposing retirees to market volatility and longevity risk.

Whether the annuity is in-plan or out-of-plan is up for debate, as both have strengths and potential drawbacks plan sponsors should consider.

Brown says Metlife likes the simplicity of fixed-income annuities within DC plans, and supplies education about various such annuities—“over one person’s life or two people’s lives”—on its website. He adds that, for protection, when participants hit their life expectancy, MetLife supports QLACs.

The presence of an in-plan solution can especially help participants combat risk-aversion, Reddy points out. “If they have an in-plan solution, they can focus on the long term rather than the cyclical market,” he says.

According to Dial, from an execution standpoint, out-of-plan annuity options, whether immediate or deferred, make the most sense. For example, Hueler’s Income Solutions platform allows participants permitted to take early, in-service distributions to purchase annuities with part of their DC account balance. They may do so starting at age 65 or, with the QLAC option, starting at 85. Choices include a variety of institutionally priced options, he says.

An issue with in-plan annuities is portability, he notes. When the plan sponsor changes recordkeepers, the new provider would need to track substantial employee indicative information that recordkeepers do not typically keep. And, because annuities may provide different guarantees, they can be held in omnibus accounts, with performance based on the purchase date—this is more information recordkeepers would need to keep.

Still, he likes the concept if recordkeepers take up the challenge and the currently high prices become institutionalized. If the prices are right, making in-plan annuities available to participants about 10 years prior to retirement is a good idea, he says.

Reddy agrees. For the vast majority of Americans who save in a workplace plan, waiting until they retire to access a retirement income solution may be too late, he warns. “The 10 years subsequent to retirement determines the overall success rate of making income last.”

Helping Sponsors Make Decisions
According to Brown, helping plan sponsors understand the many annuity choices is not necessarily a good thing. “Advisers should help plan sponsors understand there should be simplicity in messaging and choice and understand the risks participants need to mitigate.”

For example, he says, if a participant wants to delay Social Security and needs a pay-out strategy to bridge the five years until he reaches 70, an immediate fixed-income annuity is appropriate. Other participants may want more flexibility with accumulated savings, but are concerned about outliving those savings, so a QLAC may provide the appropriate insurance protection.

If participants have too many options, inertia kicks in, he says. Plan sponsors should provide only a good, limited, competitive selection. “If it can’t be simply explained to participants, it’s probably too complex and they’ll do nothing.”

Reddy points to the importance of sponsors’ plan philosophy—whether they want to attract employees, maintain employee balances only until they go to their next job, or help them with retirement income. “If they want employees out of the plan when they separate employment, plan sponsors should choose an out-of-plan annuity. If they want to help employees with retirement income, doing that effectively can involve a fixed-income immediate annuity, QLAC or GMLB,” he says.

Dial believes the DOL’s fiduciary rule will encourage participant uptake of annuities. “Everyone has been doing an IRA [individual retirement account] rollover and then setting up an income distribution plan. If plan sponsors provide the same service level in their plan, they’ll need to provide more education and one-on-ones with participants, especially those closer to retirement, to help them decide on income solutions,” he says.

Glossary of Annuity Terms:
Immediate fixed-income annuity. This distribution option lets participants use a portion of their retirement savings to purchase an immediate income stream that is guaranteed for as long as they live; this leaves their remaining assets to be invested to potentially grow their overall portfolio. Because income annuities produce the highest level of guaranteed income per dollar of assets, the average retiree would need to save about one-third more to replicate the power of the lifetime income annuity. While a retiree trades off a bit of liquidity for the portion of assets put into an annuity, he likely will gain income overall.

Qualifying longevity annuity contract (QLAC). Also known as “longevity insurance,” this is a type of deferred fixed-income annuity (DIA) where income payments begin at an advanced age—typically 80 or 85. Approved by the U.S. Treasury Department in July 2014 for use as a distribution option in employer-sponsored individual account plans, QLACs can be purchased with the lesser of 25% of a participant’s account balance, or $125,000. Assets allocated to the purchase of a QLAC are not included in the balance used to calculate the required minimum distributions (RMDs) for participants that begin at age 70 1/2. By lowering the annual RMDs participants must take in early retirement, more money can remain in the participant’s DC plan with the potential to grow.

Additionally, by delaying payments to a later age, the participant can increase the income amount possible when the QLAC’s guaranteed income payments begin. At the time of purchase, features can be added to a QLAC that offer inflation protection and provide for a return of premium (ROP) death benefit payable to designated beneficiaries when the participant dies. However, QLACs generate the most income for the fewest options participants elect.

Guaranteed minimum income benefit (GMIB). In this approach, participants buy into a fund that provides a minimum income benefit with the potential for upside appreciation. The appreciation comes from the investment performance of the fund associated with the annuity—typically, a balanced fund. The minimum (or floor) income benefit is determined by using conservative annuity purchase rates. On retirement, the participant will receive the higher of the minimum income guarantee (the floor) or the income generated by the current annuity purchase rates applied to the market value of the account. Once the annuity is purchased, generally there is no liquidity. The participant may choose not to annuitize, and withdraw the market value of his account in a lump sum.

Guaranteed lifetime withdrawal benefit (GLWB). This option combines systematic withdrawals with a potential income guarantee. The products are often structured as a DC plan investment—i.e., a target-date or target risk fund—that can guarantee a fixed withdrawal amount regardless of a participant’s actual account balance at retirement. When the holder reaches a specified age, the assets are moved into a guaranteed fund component and “wrapped” with a guaranteed percentage withdrawal amount, say 4% or 5% of the asset base. Each year, positive investment performance will result in a reset or “step-up” of the asset base to the increased current value of the assets; the asset base is kept at the prior level in the event of a market decline. On retirement, the participant may take the guaranteed withdrawal amount, while leaving the remainder in the market. However, excess withdrawals over a stated amount and other participant actions may trigger penalties and/or reduce the guaranteed withdrawal amount.

Source: MetLife

Key Takeaways:

• The DOL has determined that sponsors need to analyze only the financial viability of annuity providers at the time of selection, not 30 years down the road.
• Some lifetime income annuities available include immediate fixed-income annuities, QLACs and GLMBs.
• Some advisers believe out-of-plan ­annuities are a wiser choice than in-plan, due to complications with portability.