When Income Is the Outcome: Reducing Regulatory Obstacles to Annuities in 401(k) Plans - PowerPoint Presentation

1. When Income Is the Outcome: Reducing Regulatory Obstacles to Annuities in 401(k) PlansMark Iwry, William Gale, David John, Victoria Johnson The Brookings Institution/Retirement Security ProjectCan DC Plans Provide Safe Income?April 18, 2019

2. Annuities in ContextRisk shift from pensions to retirement savings leaves individuals exposed to new risks and more retirees facing a dilemma: how to protect against outliving savings while enjoying current consumption and liquidity Related dilemma: how much to save and how to manage decumulation: how fast is it safe to spend absent knowledge of one’s life span?A major casualty of the risk shift is a key solution to retirees’ dilemma: guaranteed lifetime income (traditionally DB) where those who die before average life expectancy support those who live beyond averageBut apart from Social Security or a DB pension, a lifetime income solution can come from a commercial annuity with similar pooling of longevity riskAnnuity is a financial product/contract whereby individual pays insurance company for a stream of regular (often monthly) payments that continue for life or a specified term

3. Basic Types of AnnuitiesCommercial life annuity or “income” annuity vs. tax-favored accumulation or investment vehicles that can but usually don’t pay income.Fixed income annuity (guaranteed monthly amounts) vs variable annuity (amount of payment varies depending on performance of underlying investments and often not intended to pay income).Immediate vs. deferred payments (deeply deferred = longevity annuity, including QLAC starting at age 80 or 85) Single premium or pay insurance company over time (incl. accumulation annuity)Individual vs. group contracts (as in retirement plans).

4. Annuities in 401(k) and Other DC PlansAdvantages of employer plans for annuitiesGroup purchasing increases bargaining power, economies of scale, institutional pricing, professional guidance, etc.Why don’t more people buy annuities?Rational: Social security; family support; low interest rates; high costs of annuities (cover distribution costs, adverse selection, risk of general longevity increase); complexity/nonuniformity/nontransparency thwart feature/price comparisonBehavioral: wealth illusion; hit by a bus; failure to see annuity as insurance against outliving savings vs. investment/gambleRegulatory: regulatory factors impeding group purchasing in plan (next slide)

5. Focus on 3 of the Regulatory ProblemsProblem 1: Most salient: plan sponsor concerns about fiduciary liability in case of insurer insolvencyProblem 2: Limited portability of annuitiesOnce these are addressed, . . . other plan sponsor concerns will surely come to the fore: peeling the onionProblem 3: Required minimum distribution rules

6. Fiduciary Safe Harborfor Annuity Provider SelectionNeed safe harbor to allay plan sponsor concerns re liabilityERISA expects each plan to pay its own independent fiduciary to make same assessments of each insurer’s claims paying ability/financial strength. Solve either by fiduciary safe harbor or single universal indep fiduciaryScope of possible ERISA fiduciary safe harbor limited to provider selection, not contract terms or priceQuality standard? Very strong financiallyOtherwise could below-investment-grade but low-cost carriers press plan sponsors

7. Insurer’s Claims Paying Ability/Financial StrengthA safe harbor could be constructed using financial strength ratings by existing major rating organizations: pros and consRating orgs: expert, clear/definite, though not wholly independent Precedents. Former DOL regs. Market does this now. More than just investment gradeLegislation could specify or direct DOL to specify in consultation with Treasury, NAIC et al.

8. Possible alternatives to credit agency ratingsAlternative to rating agencies and expert consultants: “universal” independent fiduciary or disclosureNeither government nor for-profit: NAIC, Academy, etc.Recommendations include --Bipartisan Policy Commission (June 2016): “sponsors should be able to look to others for guidance on the financial strength of the carrier.. . [including]”insurer-financial-strength ratings from third-party analysts.”Trump Admin Treasury Report (Oct. 2017) recommended

9. Possible alternatives to credit agency ratings (cont’d) that Labor and Treasury develop proposals on “how to establish or certify one or more expert, independent fiduciary entities to assess the long-term financial strength of annuity providers. These assessments, which could be in the form of ratings or other specific metrics, could assist ERISA-governed plan sponsors in complying with their fiduciary duty obligations in selecting annuity providers for plans and enable fiduciaries to rely on such assessments as a safe harbor.” Treasury Report, Oct. 2017Another option: simply collect/disclose ratings: compile and postThis might develop on its own in the market

10. Possible Additional Annuity Safe Harbor GuidanceRelated Qualified Default Investment Alternative (QDIA) safe harborLegislation could require DOL to codify in regulations its 2014 guidance on annuity selection safe harbor regulation and QDIAsGuidance allowed QDIA to include fixed income annuities as (or within) target date fund/QDIA fixed income asset exposureFixed income annuity is “embedded” in the TDF/QDIAWould not affect plans’ current ability to offer variable, indexed, etc. annuities outside QDIA

11. Annuity PortabilityProblem: if plan discontinues offering annuity, accumulation of benefits is interrupted and employee could not withdraw annuity from 401(k) to continue contributing in IRASolution: relax withdrawal restrictions for this situation to allow rollover of annuity to IRAAnti-abuse uniformity condition

12. Related Issue: RMD ReformWhat? Age 70 ½ + RMDsWhy? Use tax preference for intended purpose, limit tax deferral, estate planningRMDs serve as guidelines for decumulation?Not optimalRestricts individuals’ choice; poorly targetedPropose radical simplification: total exemption for smaller savers -- targeted, progressive

13. RMD Reform: ExemptionSmaller saver exemption proposed in – Obama Admin budget proposal (2013)Neal proposed legislationRepublican House proposed legislation (2018)Should cost less revenue because smaller/average savers need to live on these funds in retirement

14. RMD Reform: Limiting Stretch IRA Loophole What is stretch IRA?Potential reform: plug loophole (limit to 5 or 10 years)Role as revenue offset for other provisionsTradeoff: retaining stretch IRA vs. RMD exemption for ordinary retirees

15. Other RMD ReformsRequire updates of life expectancy tables Require IRA trustees to calculate RMDsAllow IRA contributions after age 70 ½Roth IRA exemption from RMDsAnnuity buybacks in DB plansRMD-related QLAC improvements

16. ConclusionThe regulatory changes described here would be a first step toward promoting annuities in 401(k)s or other employer plansThese changes probably would only begin to “peel the onion” with respect to employer plan acceptance of annuitiesOver time, however, these and other measures should gradually help to restore the pension to our private pension system.