Treasury OK's putting 401(k) and IRA dollars into longevity annuities

As aging population lives longer, these deferred annuities insure lifetime income

Jul 1, 2014 @ 9:05 am

By Darla Mercado

Financial advisers welcomed the Treasury Department's announcement that it would ease the process by which retirement plan participants can purchase deferred income annuities.

The Treasury Department and the Internal Revenue Service on Tuesday morning announced a final regulation updating the required minimum distribution laws to make it easier for purchasers to buy deferred income annuities that start payout as late as age 85.

“Americans are increasingly recognizing that it's hard for an individual who doesn't know his or her future life span to deal with, to manage the risk of running out of assets while they're in retirement,” said J. Mark Iwry, senior adviser to the Secretary of the Treasury and deputy assistant secretary for retirement and health policy. He made the announcement at the Insured Retirement Institute's annual Government, Legislative and Regulatory conference in Washington, D.C. Tuesday.

“It's not a bad idea to be in [a deferred-income annuity] for some portion of assets; it removes the uncertainty,” said Jim Phillips, president of Retirement Resources, a firm that specializes in 401(k) plans. “But participants should know what they're getting into.”

Doug Flynn, an adviser with Flynn-Zito Capital Management, agreed. “I can look at it from the standpoint where, just like you diversify your investments and your tax picture, you might want to diversify your income in retirement,” he said.

Deferred-income annuities — also known as longevity insurance — permit purchasers to buy a contract and take income at some point in the future, for example, age 80. Though the Treasury Department and the Labor Department have acknowledged that workers could benefit from using deferred-income annuities to ensure they have enough money later in life, there were still a number of hurdles to overcome.

The biggest hurdle: Since these income streams can begin at advanced ages, they run counter to the required minimum distribution rules that require savers to take money from their qualified retirement plans at age 70½.

The Treasury's qualifying longevity annuity contracts rule, effective immediately, excludes the annuity's value from the account balance that's used to determine the RMD. This way, the client doesn't need to receive annuity payments prematurely in order to meet those mandatory RMDs.

Savers in a 401(k) or IRA can use up to 25% of their account balance, or $125,000 — whichever is less — to buy a qualifying longevity annuity. That dollar limit will be adjusted for cost-of-living increases.

Still, the increased availability of deferred-income annuities means that there will need to be more due diligence on the part of advisers, plan sponsors and workers.

Advisers need to assess whether the purchase makes sense for clients, but how do the options readily available for plan dollars stack up against what's already out there in the retail market, noted Mr. Flynn.

Naturally, there's also the question of whether the worker understands fully that the slice of money that goes into the annuity isn't a liquid asset anymore.

Mr. Phillips noted that it's important that retirement plan participants have an understanding of the degree to which interest rates factor into the deferred-income annuity.

“It would be nice to have, as part of this, a mandatory disclosure,” he said. “Individuals haven't done a good job of buying annuities that are cost efficient and that have features they fully understand.”

Nevertheless, the option to shield a portion of assets from RMDs could make for some interesting planning possibilities.

“If someone has a large IRA,” said Lauren Prince, an adviser with Prince Financial Advisory LLC, “it's like you're carving out the RMD. It's an interesting concept.”

Buyers of the qualifying longevity annuity are permitted to use a “return of premium” death benefit, according to the Treasury Department. Further, the final rules permit buyers who exceed the 25% or $125,000 in premium payments to correct that excess amount without disqualifying the annuity purchase.

Finally, the final rules facilitate the issuance of these contracts by permitting purchasers to include a statement that the contract is indeed a qualifying longevity annuity in an insurance certificate, rider or endorsement, according to the Treasury Department.

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