For most American workers, defined benefit plans with their guarantee of a lifetime income have gone the way of the dinosaurs.
For workers whose employers sponsor a retirement plan, 63% have only a defined contribution plan, such as a 401(k). Unfortunately, DC plans typically function solely as savings plans, with only a small portion (fewer than 25%) offering an annuity to provide lifelong retirement income. Moreover, even when an annuity option is available, only a very small percentage of retirees (around 6%) choose an annuity option.
At the same time, there is widespread agreement among policymakers that retirees could substantially benefit if they received some portion of their 401(k) plan balance in the form of a life annuity.
One of the key challenges to increasing use of life annuities is how to make this option available to more employees. In this regard, a rulemaking proceeding is quietly advancing in Washington, which has the potential to heavily influence the availability of annuities to section 401(k) participants.
What Your Peers Are Reading
Last year, in the Pension Protection Act, Congress directed the Department of Labor to issue regulations clarifying that the selection of an annuity contract as the optional form of distribution from a DC plan “is not subject to the safest available annuity standard under DOL Interpretive Bulletin 95-1.”
By way of background, selecting an annuity provider in connection with distributions from a section 401(k) plan is a fiduciary act, subject to the fiduciary standards of ERISA section 404(a). In Interpretative Bulletin 95-1, dealing with the selection of annuity providers for defined benefit plan distributions, DOL adopted guidance that generally requires DB plans to choose the “safest available annuity.” This guidance also required DB plans to consider numerous aspects of the issuer’s financial condition, including, among others, the issuer’s investment portfolio, the level of the issuer’s surplus and capital, and indications of the issuer’s exposure to liability.
In 2002, DOL extended the “safest available annuity” standard to DC plans, but the adoption of that standard has been widely perceived as creating a significant impediment to employers making annuities available in DC plans. This has been recognized not only by Congress, but also by DOL itself.
As a result, in September 2007, DOL issued a very significant proposed regulation. It provides a safe harbor under which a plan fiduciary is considered to act prudently in selecting an annuity as a distribution option under a DC plan, if the fiduciary takes certain steps. The steps–proposed in the form of a safe harbor–are quite involved (see chart).