Investing October 20, 2020

Understanding the Types of Annuities Retirement Plans Can Use

The goals of plan sponsors and participants will help determine which option is best.

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Understanding the types of annuities available to retirement plans and how they work is important now that the Setting Every Community Up for Retirement Enhancement (SECURE) Act is in effect, meaning provisions that encourage annuity use in plans have also been enacted.

Immediate annuities begin paying out an income stream about six months after the time of purchase, whereas deferred annuities are scheduled to begin payments sometime in the future. A variable annuity is a type of annuity contract, the value of which can vary based on the performance of an underlying portfolio of mutual funds. Variable annuities differ from fixed annuities, which provide a specific and guaranteed return.

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“There are several considerations when looking at any annuity, including the objective of the funds, the time horizon and the tax consequences,” says Jason Field, a financial adviser at Van Leeuwen & Company. “The purpose of most annuities is to provide an income stream for retirement. Some reasons someone would want to include an annuity as part of a retirement plan would be for the income, and potential lower volatility with some upside potential. The drawbacks of having an annuity in a retirement plan are liquidity issues due to the surrender period of the contracts and potentially high fees.” He adds that some individuals may lose tax benefits of annuities by purchasing them with tax-deferred dollars in a retirement plan.

Field says a variable and/or a fixed annuity could be offered in a retirement plan, and either an immediate or a deferred annuity would make sense. “Depending on the time horizon of the individual, both variable and fixed annuities could be included in retirement plans,” Field says. “Variable annuities would typically fall under the equity portion of the retirement portfolio, since most of the funds in a variable annuity are tied to one of the stock markets. Fixed annuities would likely take the place of bonds in a portfolio since they do not move up and down with the market. Both—variable and fixed—could be used alone or in conjunction with one another inside of an account.

“If someone is looking for these assets to grow, then a deferred annuity would be the way to go. This would give the annuity time to increase in value based on the type of annuity it is. If someone is only looking to create a pool of money for lifetime income, then an immediate annuity would be more suitable.”

Matt Gray, assistant vice president of Allianz Life Insurance Company of North America, says the lifetime income aspects of annuities should make them attractive to retirement plan sponsors and participants alike. “Getting some protection against risks within retirement and guaranteeing an ongoing stream of income is a critical, yet often overlooked, component of a solid retirement plan,” he says.

Like Field, Gray says he believes that both variable and fixed, and immediate and deferred annuities can work within a retirement plan,. “Both fixed and/or variable annuities could certainly be appropriate for retirement plans depending on a given plan’s objectives,” he says. “For example, fixed annuities may provide for more predictability in growth and projected future income, along with a potential for lower fees. However, they may not offer the upside potential that a variable annuity could offer, which might be an important consideration for a plan given the current low interest rate environment.

“In terms of deferred versus immediate, again, it would really depend on the objectives of the plan,” Gray continues. “Does a sponsor want participants to be able to accumulate a level of future guaranteed income while they are working or do they prefer that participants make that decision at the point of retirement? Do they want it to be a part of a default offering or will it be opt-in only? There is value in having both options available, but does a sponsor have the bandwidth or appetite to put all that in place? These considerations can affect whether a sponsor prioritizes one over the other.”

Ask the Experts October 20, 2020

What Types of Situations Does a ‘Mistake of Fact’ Plan Document Provision Cover?

Experts from Groom Law Group and Cammack Retirement Group answer questions concerning retirement plan administration and regulations.

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“I was reading my ERISA 403(b) plan document and came across a “mistake of fact” provision that permits employer contributions to be returned to the plan sponsor within a year of contribution. However, the plan does not define what constitutes a mistake of fact. Can the Experts clarify?”

Charles Filips, Kimberly Boberg, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:

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Excellent question! The mostly likely reason your plan document does not define mistake of fact is that the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code do not define a mistake of fact. Section 403(c)(2) of ERISA provides that a contribution which is made by an employer pursuant to a mistake of fact may be returned to the employer within one year after payment of the contribution. However, ERISA section 403(c)(2) does not provide guidance as to the scope of situations that may result in a mistake of fact. Nor does IRS Revenue Ruling 91-4, which includes a similar mistake of fact rule, and is based on the same “exclusive benefit” rule that applies to many 403(b) plans.

Case law and certain Private Letter Rulings (PLRs) issued by the IRS over the years offer some insight into what situations may result in a mistake of fact. As a general matter, mistakes of fact under ERISA have been narrowly construed by the courts and are mostly limited to clerical errors regarding the calculation of the amount of contributions. See Irigaray Dairy v. Dairy Employees Union Local No. 17 Christian Labor Association of the United States of America Pension Trust, 153 F. Supp. 3d 1217 (E.D. Cal. 2015). However, the following examples offer some insight into the circumstances that have given rise to a mistake of fact under Section 403(c)(2):

  • In Service Employees Intern. Union Local 82 Labor-Management Trust Fund v. Baucom Janitorial Service, Inc. 504 F. Supp. 197 (D.D.C. 1980), a payroll clerk’s failure to follow specific instructions regarding the calculation of a plan sponsor’s contribution to a pension fund resulted in a mistaken calculation that led to excess contributions to the plan. The court held that the plan sponsor was entitled to an offset for excess payments made within one year prior to the date the trust fund received notice of the mistake because the clerk’s arithmetical error constituted a mistake of fact under ERISA section 403(c)(2).
  • In PLR 20128055, the plan sponsor purchased a single-premium group annuity contract to pay benefits due under the plan. The premium was calculated by the insurer based upon participant data provided by the plan, which was based on internal actuarial assumptions. The plan’s assets were insufficient to pay the single-sum premium and the employer made additional contributions to cover the balance owed. Subsequently, the insurer discovered certain errors regarding the plan-provided participant census data, which generated premium refunds from the insurer to the plan that the plan trustee desired to return to the plan sponsor pursuant to the terms of the plan. The IRS concluded that the amount of premium refunds was the result of an incorrect actuarial computation due to a mistake of fact and could be returned to the employer after satisfaction of all liabilities with respect to employees and their beneficiaries under the trust.
  • In PLR 201839010, after a plan sponsor terminated its single-employer tax-qualified defined benefit (DB) plan, the plan sponsor contributed to an amount to cover the unfunded cost of a group annuity contract for the plan participants and beneficiaries. After the annuity contract was purchased, it was determined that the plan overpaid because a number of annuitants covered by the contract were no longer living. The amount of overpayment was returned to the plan and then returned to the sponsor on grounds that a mistake of fact occurred due to a mistaken belief about the number of participants. The IRS found that the mistaken belief was a mistake of fact as contemplated under ERISA section 403(c)(2)(A), and that the return of the overpayments to the plan and plan sponsor did not violate IRC section 401(a)(2) or constitute an employer reversion under IRC section 4980(c)(2)(b).

With respect to PLRs that address mistake of fact, it is important to remember that PLRs are binding on the IRS with respect to the taxpayer requesting the ruling only. However, although PLRs may not be relied upon as precedent by other taxpayers or IRS personnel, they may have persuasive authority. As such, with respect to a mistake of fact, PLRs can be helpful and instructive to plan sponsors when working with their counsel to determine proper plan sponsor conduct. Having said this, plan sponsors should always consult with retirement plan counsel well-versed in such issues before using a plan’s mistake of fact provision.

 

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

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