Lifetime income options, such as annuities, can undoubtedly play a valuable role in most (if not all) clients’ retirement income planning strategies — a fact that has been widely recognized by government agencies in recent years.
The Government Accountability Office (GAO) is the latest entity to respond, and it has released a recommendation designed to allay plan sponsors’ fear of fiduciary liability under the current rules, which, coupled with the fact that the bulk of an average client’s retirement savings may be held in a 401(k), may be hindering the middle market client’s ability to purchase a lifetime income product.
As a result, the GAO has recommended that the Department of Labor (DOL) modify its rules governing plan sponsors’ fiduciary liability in order to facilitate the availability of in-plan annuity products within 401(k)s.
The current 401(k) rules
The current rules for offering lifetime income options (in the form of annuities) within a 401(k) are known as safe harbor requirements that can allow a plan sponsor to make an in-plan annuity option available without fear of fiduciary liability. The safe harbor rule requires the plan sponsor to assess the costs and benefits of the annuity (using the standard of prudence that generally applies in the fiduciary context) when selecting which annuities will be available for purchase within the plan.
Additionally, the safe harbor requires a plan sponsor to assess an annuity provider’s ability to make all future payments under the annuity contract at the time the contract is selected as an in-plan option. Although the DOL recently released a field assistance bulletin clarifying that the plan sponsor’s fiduciary duty to monitor the annuity provider’s financial capabilities ends when that insurer’s annuities are no longer offered as distribution options by the plan, many plan sponsors have still been reluctant to take on the responsibility created by offering the annuity option in the first place.
In fact, GAO research has found that only about 25 percent of all plans have chosen to offer an in-plan annuity option, and only about one-third of plans have adopted some form of withdrawal option to help participants manage their funds after retirement.
401(k) plan sponsors’ reluctance to offer in-plan annuity options has prompted the GAO to recommend that the DOL clarify and modify its safe harbor provision to encourage the availability of these lifetime income options. The GAO report recommends that the DOL provide a more detailed set of criteria that must be used by a plan sponsor to evaluate the insurance carrier’s capabilities in order to avoid potential fiduciary liability.
For example, many plan sponsors indicated that they would be more likely to offer in-plan annuity options if they had access to a list of insurance carriers that qualify as prudently selected annuity providers. In lieu of such a list, sponsors found it would be useful for the DOL to provide a minimum rating that an annuity provider must receive from certain named credit rating agencies in order to qualify as a prudently selected provider.
The GAO has also recommended that the DOL provide limited liability relief for plan sponsors that offer an appropriate mix of lifetime income options.
While this recommendation would encourage a more widespread offering of in-plan annuities, the GAO has also recognized the potential importance of plans that offer required minimum distribution (RMD)-based default lifetime income options. This would involve the plan sponsor calculating and providing RMD payments from the 401(k) that are designed to last for the participant’s lifetime, regardless of whether the participant has actually reached age 70 ½ when he or she begins to withdraw funds.
Further, the GAO recommends that plan sponsors be encouraged to offer partial annuitization options, so that the participant can choose the amount of guaranteed lifetime income that is most appropriate for his or her individual circumstances.
While the DOL has responded with concerns that the GAO recommendations could lead to decreased consumer protection, it has shown that it may be willing to consider some of these suggestions over the long term — potentially leading to an increase in lifetime income options for the average client.