Retirement income planning can be a complex arena where academics, theory, practice, products and people collide. I often describe income planning as trying to hit a moving target in the wind. The target is each individual’s goals for retirement – what they want to do and how they want to spend their money. It moves because you can’t predict how long a person will be in retirement – it could be one year, or it could 40 years.
And the wind? External factors like the markets, laws and other more macro-level events that fluctuate.
Lately, there has been a lot of external influence with COVID-19 and the resulting market volatility. A retiree during this time might wish to have some level of secure income in retirement rather than check their retirement portfolio each day. This is where bond ladders and annuities come into play. And if the SECURE Act, which was passed at the end of 2019, has the impact many anticipate, investors can expect to see more and more annuities showing up in their 401(k) plans over time.
Annuities generate income in a retirement plan by creating a floor of income that the individual cannot outlive and that is not impacted by the ups and downs of the daily markets. This article looks at how the SECURE Act’s new provision to allow in-plan annuities affects the annuity marketing going forward.
Let’s start by reviewing the new law. Congress passed the SECURE Act during the final days of 2019.
Think of the SECURE Act as enacting three key changes for retirement income planning. First, it gives annuities a big boost. Second, it encourages small business owners to set up retirement plans. And third, it significantly changes the distribution rules around IRAs.
Section 204 of the SECURE Act created a Fiduciary Safe Harbor Provision for the Selection of Lifetime Income Providers inside of qualified retirement plans like 401(k) plans. The goal of this provision was to lessen the liability of a plan fiduciary when selecting an insurance company to provide annuities as investment options inside of the plan.
To be frank, however, selecting an appropriate annuity, looking at the riders and fees, and vetting the insurance company that provides the annuity are complex tasks. Many small business owners and plan providers are not up for the job as is required under ERISA fiduciary law. This can be seen in the number of plans that have annuities as investment options. For example, fewer than 10% of plan sponsors have made moves to include annuities as a 401(k) investment option.
Reducing this liability and providing a simplified vetting process for plan fiduciaries is one way to introduce more annuities into retirement plans. The fiduciary must follow a number of steps in the vetting process to receive the safe harbor.
For instance, the fiduciary must still review whether an insurance company can meet its financial obligations, consider the costs of the annuity contracts, and conclude that at the time of the selection, the insurer is able to carry out its promised obligations. The fiduciary will be deemed to understand the financial capability of the insurer if they:
- obtain written representation from the insurer that it is licensed to offer the contracts
- have not had their license revoked or suspended for the last seven years
- file appropriate documents with the state regulatory department
- maintain appropriate state-mandated minimums in all states where they do business
- are not under a supervisory operating structure
- undergo a financial assessment by the insurance commissioner at least once every five years.
The insurance company must agree to notify the fiduciary of any changes to the aforementioned provisions.
Will this new safe harbor provision open the flood gates, and lead to all 401(k) plans soon adding annuities to their investment options? The answer I got when I spoke to Dylan Huang, Senior Vice President and Head of Retail Annuities at New York Life, surprised me.
He said that he did not see the SECURE Act’s provision as “opening the flood gates” because many 401(k) plans and participants were not yet ready for the conversation.
Huang stressed a very important point when it comes to adding annuities inside of retirement plans: “The value proposition of income annuities as part of a retirement income plan is a very strong one, but annuities need to be used inside of a retirement income plan and not in silos.”
This highlights a concern that annuities are not one-size-fits-all. For instance, a young 401(k) participant who is early in their career might not be a suitable investor for all types of annuities. However, since most 401(k)s leave this investment decision up to the participant, without further planning or guidance, the individual might end up in an unsuitable selection.
What is the right solution? Huang suggests plan participants and 401(k) plans need more education. Without planning and education, the annuity products alone won’t lead to the best outcomes for participants and won’t lead to the best asset allocation decisions.
In fact, Huang indicated that most plans likely need retirement income and product education before they even consider adding annuities into their plans. Ultimately, Huang sees income planning as a personal process that needs a guiding hand, education and serious diligence.
Huang also highlighted another challenge facing employers who wish to offer annuities in plan.
“Perhaps the biggest impediment to significant in-plan annuity sales is that they are offered in the context of a platform designed for ‘set it and forget it’ interactions,” Huang said. “Employees generally go into these platforms a handful of times a year, they set their contributions high enough to get their employer match if that is offered and they log out. It’s a very transactional experience that doesn’t lend itself well to employees understanding the different dimensions of risk they are likely to encounter in retirement.”
If plans start to add more annuities as investment options, where does this leave the average investor? Under today’s laws and 401(k) setup, the onus of planning is on the individual. As such, individuals will likely need to reach out to advisors and other financial professionals for guidance on plan investments, as well as best practices for retirement income planning.
Huang agreed, saying, “For in-plan annuities to be truly successful, employers will need to consider offering some element of education – preferably through a human – for these products to really take off in-plan. In the near term, we are likely to see more employees kicking the tires on annuities in plan but ultimately making a purchase decision out of plan after talking to a financial professional.”
While the SECURE Act unlocked the door for annuities to enter retirement plans, those plans still need to open that door and adopt these types of investments. But whether they offer annuities, retirement plan sponsors should make sure they have the right education, financial wellness and systems in place to help support their plan participants in making informed investment decisions. No one wants plan participants to invest in annuities when they are not suitable for their goals because they did not have the proper education and guidance on their options.
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