Getting SECURE Act’s Lifetime Income Provisions Right

Retirement industry analysts broadly agree the passage of the “SECURE Act” late last year marked the most significant change for the retirement industry in more than a decade.

The landmark legislation includes substantial adjustments to the regulatory systems controlling the operation of defined contribution (DC) plans, pension plans, individual retirement accounts (IRAs) and 529 college saving plans. It also creates a new marketplace for “open multiple employer plans (MEPs),” which will effectively mirror DC plans but will be open to joint participation by otherwise completely unaffiliated companies.

In the view of Ross Bremen, a partner in NEPC’s defined contribution (DC) practice, the SECURE Act’s lifetime income-focused provisions are probably paramount, though the open-MEPs discussion is also crucial.

Altogether, the SECURE Act includes three improvements that should expand plan sponsors’ ability to offer annuities and other lifetime income products. First, it establishes an in-plan retirement income safe harbor that protects employers from litigation based on their selection of annuity providers; it creates a new requirement that the Department of Labor (DOL) mandate and standardize the provision of recurring lifetime income projections for individual participants; and it institutes an in-plan annuity portability requirement, such that if an annuity offering is removed from a plan menu, participants must be allowed to roll that annuity investment into an IRA without penalty.

“These protections to lifetime income products appear to have answered sponsors’ prayers,” Bremen tells PLANSPONSOR. “For plan sponsors and regulators alike, there is a lot of work that will need to be done in the coming months. We might not immediately see a tidal wave of annuity adoption, but over time the impact could be substantial.”

Diligence is demanded

Dan Keady, chief financial planning strategist at TIAA, agrees with Bremen’s assessment, telling PLANSPONSOR that the accurate provision of lifetime income provisions is of the upmost importance.

“With the SECURE Act, we can expect these lifetime income projections to become much more front-and-center in the communications and statements sent to participants,” Keady says. Some will be shocked by the figure they see expressed as a monthly retirement check rather than a lump sum, whereas others, perhaps Millennials who have been saving aggressively and have a long career path ahead of them, may react very positively to their projections. Either way, it’s going to be up to plan sponsors to help participants understand the information they are presented.  

“Naturally, ensuring the reliability of the projected income figures is a big topic,” Keady says. “We can expect that there will be some guiding regulations issued by the Department of Labor sometime in the near future. From our experience and perspective at TIAA, we understand that these figures are going to be generic when they are first set up, so we have to encourage people to go into the system to personalize their information.”

For example, if the generic projection is considering the theoretical purchase of a joint and survivor annuity, one can’t just assume both partners are the same age. Details like that are needed to ensure the reliability of any lifetime income projection. Given this challenge, Bremen and Keady say, plan sponsors, working in concert with their service provider partners, will have to work hard to help people understand whether they are on track or not.

“For those who are discouraged by the new projections, we can show them how making small steps today can have a big impact down the line,” Bremen says.

Importance of the default

Bremen observes that annuity products being included in DC plans won’t automatically mean such solutions are popular among participants.

“We already know that new, standalone investment choices tend to not get a lot of traction, while at the same time, the default investment tends to get the vast majority of contributions,” Bremen says. “So it’s going to be important to watch how the new annuity selection safe harbor impacts the way people talk about the default investment, and how they choose their default investment. Will it include annuities? There has in fact already been some specific regulatory guidance on the topic of integrating annuities into default investment funds, and now with the SECURE Act, we may get even more guidance.”

Keady says he is eager to see how DC plan investors think about annuities once their fiduciary plan sponsors start talking about them more, post-SECURE Act, especially given that individuals tend to put a lot of trust in their employers. He feels there are generally three camps of DC plan investors to consider, at least when it comes to the discussion of annuities and lifetime income.

“You could think of three groups of participants that we are dealing with here, one of which is small but very mathematically or academically minded, and they already understand why annuities make sense,” Keady explains. “They are happy to give up a significant sum of money in exchange for an open-ended income guarantee for life. These will be the early adopters.”

The second group, also relatively small, will never give up their principal and will always prefer to maintain full control over their assets. In the middle stand the vast majority of real-world DC plan investors, who don’t know much about the topic of annuities/guaranteed income and can probably be convinced either way.

“We want more people to be open to annuities, because the academics agree that including a low-cost, institutionally priced, fixed annuity option makes a lot of sense for most people participating in DC plans,” Keady says. “The research shows clearly that annuitizing some portion of one’s DC plan balance almost always makes sense from a risk-reward perspective. It’s not about annuitizing every dollar, but instead about building an income floor that one cannot outlive.”