The passage of the Secure Act in 2019 has led to some dramatic shifts in retirement plans. Of particular note, the law allowed for annuities providing guaranteed lifetime income to be incorporated into 401(k) and 403(b) plans. Such products enable plans to more closely resemble traditional pension plans.
The proposed LIFE Act would allow plan sponsors to put as much as 50% of each participant’s assets into an annuity default option.
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As important as that shift was, if the newly proposed ‘‘Lifetime Income For Employees Act” passes, it will amplify the Secure Act’s effects significantly. Introduced to the House of Representatives by Reps. Donald Norcross (D., N.J.) and Tim Walberg (R., Mich.) this February, the LIFE Act would change U.S. Department of Labor rules to allow plans to make annuities a default investment for participants.
Qualified Default Investment Alternatives, or QDIAs, account for a significant portion of retirement plan assets. According to financial services behemoth Vanguard, at the end of 2020, 62% of its 4.7 million defined contribution (DC) plan participants were solely invested in an automatic investment program, often a single default target-date or asset allocation fund.
The Secure Act did not allow annuities to be default options because of the DOL’s liquidity requirements. Currently, a QDIA has to be liquid enough to allow plan participants to withdraw their assets or transfer those assets to a different investment option at least once every 90 days. But annuities often require longer investment lockups.
“A lot of annuity products, especially guaranteed fixed annuity products, have some sort of liquidity restriction built into them in order to provide the guarantees that they offer,” says Chris Spence, head of federal government relations at TIAA, a major annuity provider that has shown support for the LIFE Act.
The LIFE Act would allow plan sponsors to put as much as 50% of each participant’s assets into an annuity default option. Participants would have 180 days after the plan sponsor does this to get out of the annuity and avoid any liquidity restrictions. They would also have to be notified 30 days before the liquidity restrictions were to occur.
Because of its bipartisan support, Spence thinks the likelihood of the LIFE Act passing is strong. While locking up employee assets in a retirement plan annuity could mean fewer assets for financial advisors to manage outside of plans, Spence doesn’t think annuities will diminish the demand for financial advice. “You still need financial advice to know how much you should be allocating to that annuity,” he says. “In some ways, it’s going to encourage people to be more proactive about their financial planning and really thinking about how to spend [their annuity and other income] in retirement.”
There are a few important considerations the LIFE Act doesn’t mention. One is the kind of guaranteed annuities that could be employed as QDIAs. Structurally, the new annuities in plans currently available vary significantly. Some, such as State Street’s IncomeWise, employ a qualified longevity annuity contract, or QLAC, structure that begins paying guaranteed income when a participant turns 80. Others, like BlackRock LifePath Paycheck, can pay income as soon as employees retire, albeit generally at a lower level than a delayed QLAC contract.
Because assets in QLAC annuities are not taxed, the IRS originally put a 25% limitation on the amount of a plan participant’s portfolio that could be invested in them, so that the QLAC wouldn’t become too valuable as a tax shelter. The LIFE Act does not state whether that limit will now increase to 50%. Nor does the LIFE Act provide any specific liquidity options or protections for plan participants locked into a default annuity who have a monetary emergency and need to liquidate. Yet some specific annuity products do provide such liquidity options.
Currently, the kind of guaranteed lifetime annuities plan sponsors can use is largely at their discretion, and the LIFE Act would leave that flexibility in place. “Nothing in the bill describes or prescribes how the insurance company [issuing the annuity] is going to invest those assets and what assumptions are going to be used to determine how much retirement income is going to be purchased for, say, every hundred dollars invested,” says John J. Nestico, a retirement plan lawyer at Schneider Wallace Cottrell Konecky LLP who is opposed to the bill. “That’s the essential unknown about this proposal.” Nestico is worried the guaranteed payouts will be too low for retirees.
Potential opportunity? Because there is so much variability in product features, more annuity options in plans could lead to more people hiring financial advisors for advice on allocating 401(k) investments. One area where advisers would add value is helping investors understand which kinds of annuities make sense for them and which to avoid. Platforms to help advisors manage clients’ employer-sponsored retirement accounts, such as 401(k)s, are growing. Pontera, formerly named FeeX, just got $80 million in new funding from backers.
Fees for annuities have historically been high, but that’s because they have largely been a retail product. 401(k) plan annuities benefit from institutional pricing. BlackRock, for instance, charges 0.10% of assets for its regular target-date funds in plans on average and caps costs at 0.16% for such funds with lifetime annuity features. Traditionally, lifetime income annuities have charged about 1% of assets.
Given that institutional pricing, some of these new annuities might be worth advisors’ support.