The Build-A-Pension Trend.
As most clients know, employer-sponsored pension plans have become a luxury that's primarily a thing of the past. For the typical client, retirement income planning is accomplished through accumulation in an employer-sponsored 401(k), which provides no guarantee that accumulated assets will last as long as the client.
Fortunately, this "longevity risk" has become such a concern that the IRS and Treasury have eased some of the rules that previously made it more difficult for clients to take proactive steps to protect against the risk--and both clients and their employers are now beginning to jump on the build-a-pension bandwagon in greater numbers, taking advantage of newly attractive longevity income annuity options.
Longevity Annuity Contracts
A longevity annuity contract is essentially an annuity contract that is purchased with retirement assets (whether from a 401(k), 403(b) or traditional IRA), under which the annuity payments are deferred until the client reaches old age in order to provide retirement income security late in life.
In order to be a "qualified longevity annuity" or QLAC, payments must begin by the month following the month in which the client reaches age 85, and the client is limited to a contract with an annuity premium value equal to the lesser of 25 percent of the value of the retirement account in which it is held, or $125,000.
However, if the longevity annuity qualifies as a QLAC under the new rules, the value of the QLAC is excluded from the retirement account value when calculating the client's required minimum distributions (RMDs) once the client reaches age 701/2--giving clients an added incentive to take advantage of the longevity annuity option.
Default 401(k) Investment Options
The Treasury department has also made it easier for individuals to protect against longevity risk by investing in deferred annuities through 401(k) plans. The rules now specifically permit 401(k) plan sponsors to include deferred annuities within target date funds (TDFs) without violating the nondiscrimination rules that otherwise apply to investment options offered within a 401(k). This is the case even if the TDF investment is a qualified default investment alternative (QDIA), which is a 401(k) investment that is selected automatically for a plan participant who fails to make his or her own investment allocations.
Further, Treasury rules now provide that the TDFs offered within a plan can include deferred annuities even if some of the TDFs are only available to older participants--and even if those older participants are "highly compensated"--without violating the otherwise applicable nondiscrimination rules. Similarly, the nondiscrimination rules will not be violated if the prices of the deferred annuities offered within the TDF vary based on the participant's age.
The rules allow plan sponsors to include annuities within TDFs even if a wide age variance exists among the plan's participants. Additionally, the rules allow plan sponsors to provide a participant with guaranteed lifetime income sources even if the participant is not actively making his or her own investment decisions with respect to plan contributions--a situation that is increasingly prevalent as employers may now automatically enroll an employee in a 401(k) plan unless the employee actively opts out of participation.
The Fine Print
Generally, only clients who are in relatively good health and expect to live long enough to reap the benefits of the strategy should be advised to invest in either a QLAC or a traditional deferred annuity with their retirement account assets.
Further, the strategy will primarily benefit middle income clients, as very high net worth clients likely have other options available to protect against longevity risks, and lower income clients may not have the resources available to annuitize. Clients should also be advised that only a portion of their retirement assets should be tied up in an annuity that is only accessible later in life.
Traditional pensions may never make a comeback--but for many clients, creating a certain stream of pension-like income during retirement may now be a possibility.
Check out previous coverage of QLACs in Advisor's Journal, and for in-depth analysis of annuity types, see Advisor's Main Library.
Your questions and comments are always welcome. Please post them at our blog, AdvisorFYI, or call the Panel of Experts.
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|Date:||Jun 21, 2017|
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