Annuities in Retirement Plans Gaining Interest
Annuities in Retirement Plans is a topic that has been the subject of heated debates since the inception of ERISA. There are strong feelings on both sides of the argument of whether it is appropriate to place a tax-deferred investment, in the form of annuities in retirement plans. Enter the new Act from the U.S. Congress. The Setting Every Community Up for Retirement Enhancement Act of 2019, more commonly known as the SECURE Act, is poised to make sweeping changes to retirement plans, including a relaxing of the rules surrounding employer liabilities related to offering annuities in those plans. The legislation passed the House in late May and is now under consideration by the Senate. The SECURE Act contains approximately two dozen rule changes for retirement plans. These rule changes include extending the age workers can contribute to their Individual Retirement Accounts (IRAs) and allowing small employers to band together to offer Multiple Employer Plans (MEPs) to enable their employees to save for retirement.
The SECURE Act contains another provision addressing annuities in retirement plans. This is a provision that insurance companies support. However, this same provision is a source of concern for some consumer advocates, according to the New York Times. The provision would remove some of the liability for employers who choose to offer annuities as an option in their 401(k) plans. Annuities by nature are often reputed to be complex and expensive, however, they are touted as products that offer peace of mind and a steady income stream for life. However, the annuity sales pitch often leaves out the potential downsides of annuities. Those being, tax consequences (annuity withdrawals are taxed as ordinary income); the fact that the income may cease when the annuitant passes away; that they are often accompanied by steep surrender charges, penalties and other fees; and that annuities are only as a good as the insurance company that’s offering them. Meaning if the company experiences financial challenges or goes out of business, annuity owners could potentially lose the entire investment.
Some experts say the offering of annuities in retirement plans is a “detriment to retirement savers.” The complexities and expenses may, indeed, be drawbacks. However, annuities may make sense from the standpoint of creating a paycheck for retirees. Many people save in a retirement plan over the course of a 30- to-40-year career, then retire with a sum of money that they don’t know how to transform into a stream of income. This is an issue many retirement plan participants struggle with — accessing their savings to support themselves in their post-work years. Annuities could potentially help make this easier. However, annuities come with added costs, which can be confusing and difficult to understand.
Maintaining retirement savings in a high-cost annuity could reduce savings over time, leaving workers with less money to live on in their post-work years. The same concern has existed over offering higher vs. lower-cost investment options in retirement plans — higher fees could mean potentially less income at retirement, as they tend to erode any earnings gained over time. As employers have moved away from providing traditional pension plan benefits, they have experimented with offering annuities in their retirement plans. Money management behemoth BlackRock is also working on alternative methods to provide guaranteed income streams in workplace retirement plans.
The provision contained in the SECURE Act is designed to get employers more comfortable with the idea of offering annuities in retirement plans, according to the New York Times. Employers must act as fiduciaries, and as such, choose the retirement plan options that serve their participants’ best interests. Annuities may ultimately be the solution for many employers and states who are struggling under the burden of their underfunded pension plans.
Thus far, employers have been hesitant to embrace annuities because they feared the liabilities that came with offering a product that isn’t guaranteed. In other words, employers are vulnerable to lawsuits if an insurer is unable to meet its obligation to pay annuity owners — an event that could happen decades after the impacted employee has left a company.
However, the SECURE Act helps mitigate these concerns, because it protects employers from such liabilities. If the insurer offering the annuity became insolvent and therefore unable to meet its obligations to annuity owners, “retirees would be able to seek redress from state insurance guaranty associations, which would provide a backstop to their benefits up to certain limits,” per the Times.
As such, if the legislation passes as written, it is critical for employers and retirement plan fiduciaries to carefully evaluate and keep a close eye on the annuity products they choose. Anything less than the utmost diligence could leave employees with an annuity from an insolvent insurer, which might require government intervention, or could result in the total loss of their life savings. As such, fiduciaries will be responsible not only for evaluating the appropriateness of the fees and the annuity product itself, but also the financial health of the backing insurer. So while on paper, annuities in retirement plans may seem like a solid answer to creating a lifetime paycheck from workplace retirement plans, their complexities, high costs and the solvency of insurers will need careful consideration if the provisions written into the SECURE Act are passed into law.