As most clients know, employer-sponsored pension plans have become a luxury that’s primarily a thing of the past. For the typical client, retirement income planning is accomplished through accumulation in an employer-sponsored 401(k), which provides no guarantee that accumulated assets will last as long as the client.
Fortunately, this “longevity risk” has become such a concern that the IRS and Treasury have eased some of the rules that previously made it more difficult for clients to take proactive steps to protect against the risk—and both clients and their employers are now beginning to jump on the build-a-pension bandwagon in greater numbers, taking advantage of newly attractive longevity income annuity options.
Longevity Annuity Contracts
A longevity annuity contract is essentially an annuity contract that is purchased with retirement assets (whether from a 401(k), 403(b) or traditional IRA), under which the annuity payments are deferred until the client reaches old age in order to provide retirement income security late in life.
In order to be a “qualified longevity annuity” or QLAC, payments must begin by the month following the month in which the client reaches age 85, and the client is limited to a contract with an annuity premium value equal to the lesser of 25 percent of the value of the retirement account in which it is held, or $125,000.
However, if the longevity annuity qualifies as a QLAC under the new rules, the value of the QLAC is excluded from the retirement account value when calculating the client’s required minimum distributions (RMDs) once the client reaches age 70½–giving clients an added incentive to take advantage of the longevity annuity option.
Default 401(k) Investment Options
The Treasury department has also made it easier for individuals to protect against longevity risk by investing in deferred annuities through 401(k) plans. The rules now specifically permit 401(k) plan sponsors to include deferred annuities within target date funds (TDFs) without violating the nondiscrimination rules that otherwise apply to investment options offered within a 401(k). This is the case even if the TDF investment is a qualified default investment alternative (QDIA), which is a 401(k) investment that is selected automatically for a plan participant who fails to make his or her own investment allocations.
Further, Treasury rules now provide that the TDFs offered within a plan can include deferred annuities even if some of the TDFs are only available to older participants—and even if those older participants are “highly compensated”—without violating the otherwise applicable nondiscrimination rules. Similarly, the nondiscrimination rules will not be violated if the prices of the deferred annuities offered within the TDF vary based on the participant’s age.