Annuity Safe Harbor

The SECURE Act would implement many amendments to retirement account rules designed to encourage retirement savings and retirement plan offerings. One of those amendments would aim to make it easier for retirement plan sponsors to give plan participants the option of purchasing an annuity within their 401(k) account in order to provide a pension-like stream of income throughout retirement. While easing participant fears of running out of retirement funds has always been a goal, many plan sponsors avoid offering annuity options because of the potential fiduciary liability associated with the annuity itself. Because the ongoing monitoring requirements that would otherwise apply have tended to prevent the 401(k)-annuity investment option, the SECURE Act would provide a safe harbor for plans that did provide an annuity option.

We asked two professors and authors of ALM’s Tax Facts with opposing political viewpoints to share their opinions about the potential impact of the safe harbor rule.

Their Votes:

Byrnes

Bloink

Their Reasons:

Below is a summary of the debate that ensued between the two professors.

Byrnes: I think the safe harbor is absolutely necessary because we need to do everything we can to encourage taxpayers to purchase guaranteed lifetime income products. Americans are living longer than ever and very few now have access to a traditional pension plan that would provide a steady stream of income throughout their entire retirement. Even more concerning is the number of Americans who don’t have the necessary savings to live in the style that they are accustomed to throughout a retirement that could last decades. The annuity option can provide a solution to all of these problems.

Bloink: I do agree with Professor Byrnes that we need to provide 401(k) participants with the opportunity to invest in annuities for lifetime income protection purposes. Where I diverge is in this safe harbor rule. The safe harbor basically eliminates the plan sponsor’s ongoing fiduciary responsibilities with respect to the annuity product, giving the sponsor very little incentive to thoroughly vet the annuities that it allows in its 401(k) plan—in other words, this safe harbor creates conditions where it’s likely that an unsophisticated 401(k) participant could purchase an annuity that’s not what the participant really needs.

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Byrnes: If we don’t eliminate the onerous fiduciary requirements with respect to ongoing monitoring of these annuity products, we’re never going to see these valuable tools show up in 401(k)s. The DOL fiduciary rule is gone for now, but it’s likely to be revived shortly in some form—with all of this intense regulation at the agency level, plan sponsors can’t risk potentially becoming embroiled in ongoing litigation as a result of the annuity product offering. The safe harbor requires the plan sponsor to do the necessary due diligence upon selecting the annuity—with a seven-year lookback period into the annuity provider’s history and financial stability.

Bloink: What Professor Byrnes is overlooking is the extreme complexity of annuity products in today’s market. What this safe harbor does is open the door for allowing overly complex and unnecessarily expensive annuity offerings into the 401(k), and because the plan sponsor has no ongoing fiduciary responsibilities with respect to these offerings, we could see financially unsophisticated participants locking themselves into annuity products that they don’t even fully understand. Fiduciary liability exists exactly to protect investors against this potential outcome, and I don’t think we should eliminate the plan sponsor’s responsibilities with respect to an issue that’s so important for so many.

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Byrnes: Many Americans don’t have the option of purchasing an annuity outside of a 401(k) as it is—because the employer-sponsored 401(k) is their only significant savings tool. The unfortunate reality is that while plan sponsors can give participants the tools they need for a successful retirement, they usually don’t because they’re afraid of being sued by plan participants when they don’t like the option’s performance down the road. We need to eliminate this risk in order to give participants an option—and remember, it’s just an option, participants would not be required to purchase the annuity.

Bloink: What we need are adequate safeguards with respect to these product offerings. Yes, in some cases people have to tap their retirement funds as the only option for purchasing a product like this. But do we really want to make it easier for 401(k) participants to purchase potentially unsuitable products that they may not even fully understand? It’s the plan sponsor’s duty to protect participants’ 401(k) assets to the extent possible—we know the system isn’t perfect, but removing a critical layer of investor protection is not the way to fix the problem.