Lifetime income to reach defined-contribution retirement plans, but not anytime soon

New guidance from the IRS and Department of Labor on using annuities in target date funds will encourage greater use of lifetime income options in defined-contribution plans.
But don’t expect an immediate rush by DC plans to embrace such options. The reason: Existing products don’t fit within the broad guidelines published by the IRS and DOL governing a lifetime income option that contains a deferred annuity offered within a target date fund.
“We are telling clients we view this as a step in the right direction,” said Marla Kreindler, a Chicago-based partner at Morgan Lewis & Bockius. She added it will “take time” for new products to reach the market and gain sponsor acceptance.
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Defined-contribution consultant Sue Walton called the guidance “a first step” that “will certainly increase the opportunity for conversation” among providers.
“We do not believe there is a product readily available in the market today that meets the guidelines outlined by the DOL and Treasury,” said Ms. Walton, a director at Towers Watson Investment Services in Chicago. “A number of the major providers are considering solutions.” She declined to name any.
Consultants and lawyers said the actions by the IRS and DOL provide greater clarity and comfort for employers that might consider offering a target-date fund series in which a deferred income annuity is embedded. The target date fund series can serve as a qualified default investment alternative or as a regular investment option.
The IRS guidance said the use of deferred income annuities within a target date structure doesn’t violate nondiscrimination rules as long as other IRS guidelines are followed.
The Labor Department said the IRS guidance meets the qualified default investment alternative standards in the Employee Retirement Income Security Act as long as plan sponsors follow department rules on annuity contracts.
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“It’s a clear signal of Washington’s interest in retirement income,” said Amy Reynolds, a partner and U.S. defined-contribution consulting leader for Mercer. “Our expectation is that this will open the door for investment managers to create products. There’s a lot of legwork to be done.”
Ms. Reynolds and other DC experts said lifetime income products now on the market wouldn’t be affected by the new IRS and DOL guidelines. “There’s not necessarily a single answer” to a lifetime income solution, she said.
The regulators’ actions don’t address some key issues necessary for wider adoption of lifetime income options, those interviewed said. One is the need to create attractively priced products that avoid confusing participants and aren’t difficult to administer.
“These barriers are being broken down,” said Christopher Lyon, a partner at Rocaton Investment Advisors. “Providers and record keepers are addressing cost, complexity and portability” in developing products. He wouldn’t identify them.
The IRS and DOL guidance “will be one of the milestones” in the growth of lifetime income options, Mr. Lyon added.
A recent Towers Watson survey of 345 DC plan executives found the biggest impediments to offering lifetime income options were concerns about fiduciary risk, lack of participant demand and complexity of administration.
Perhaps the biggest regulatory issue is plan executives’ concerns about their fiduciary responsibilities of selecting annuity providers in their lifetime income products.
Although some DC plans have lifetime income options, “our sense is that sponsors are still uncomfortable about a safe harbor” for selecting annuity providers, said Louis Mazawey, a principal at Groom Law Group.
The latest DOL guidance says sponsors “could effectively shift” the fiduciary responsibility for annuity selection to an investment manager, though doing so doesn’t mean plan sponsors are absolved from responsibility, Mr. Mazawey said. Also, it’s unclear how many investment managers would be willing to assume greater fiduciary responsibility, he said.
Mr. Mazawey and others pointed out the IRS guidance excluded annuities that provide a guaranteed lifetime withdrawal benefit or guaranteed minimum withdrawal benefit feature within a DC plan. A footnote in the IRS document said the Treasury Department and IRS “are considering whether or not to provide guidance related to issues from the use of … [these] features in defined contribution plans.”
Although initially taken aback by the IRS comments, consultants and lawyers said subsequent discussions with Treasury Department officials convinced them that the IRS wasn’t criticizing or ignoring options for guaranteed withdrawal benefits.
“The Treasury Department didn’t intend to discourage” these products, Mr. Mazawey said.
At AllianceBernstein, which provides a guaranteed withdrawal feature, senior managing director and head of defined contribution Richard Davies said, “We’re viewing this [the IRS guidelines] as generally positive.
“The Treasury Department made it clear that this was not negative,” he added. “There was no intentional slight. It could be addressed in another regulation.” AllianceBernstein has two clients — its own 401(k) plan and United Technologies Inc.
Prudential Financial Inc. also offers a guaranteed withdrawal benefit product as a stand-alone option within a DC plan, as well as a guaranteed withdrawal benefit product that can be incorporated into target date, balanced or target risk funds, or a Prudential asset-allocation program.
Based on conversations with Treasury officials, the absence of IRS/DOL guaranteed withdrawal benefit guidance isn’t viewed as negative, said Srinivas Reddy, head of full service investments at Prudential Retirement, a unit of Prudential Financial. He said regulators seem “comfortable” with guaranteed minimum withdrawal benefit products.
Prudential’s clients include its own 401(k) plan and Adventist HealthCare Retirement Plan.
Also unaffected by the guidance is a lifetime income product from Empower Retirement that features a contingent deferred annuity, said spokesman Jon Goldstein.
This annuity “wraps a portion of a participant’s account in order to guarantee a stream of income payments,” Mr. Goldstein wrote. “The participant’s ability to benefit from the CDA is contingent upon the participant’s covered account dropping below zero.”
He declined to identify any of Empower’s lifetime income option clients.
Robert Steyer is a reporter at sister publication Pensions & Investments.