562 / What are the SECURE Act lifetime income rules designed to increase the use of annuities in 401(k)s?

The SECURE Act created a fiduciary safe harbor designed to increase the use of annuities to provide lifetime income within the 401(k). Plan sponsors can now satisfy their fiduciary obligations in choosing the annuity provider by conducting an objective, thorough and analytical search at the outset (eliminating the need for ongoing monitoring). The sponsor must also evaluate the insurance carrier’s financial capability to satisfy the annuity obligations, as well engage in a cost-benefit analysis with respect to the annuity offering (the sponsor is permitted to rely upon a written representation from the insurance company demonstrating the carrier’s financial standing). The written representation must state that the insurance company:

• Is properly licensed,


• Has met state licensing requirements for both the year in question and seven prior years,


• Will undergo financial examination at least once every five years,


• Will notify the plan fiduciary of any changes in status.¹

From this information, to qualify under the safe harbor, the plan sponsor must draw the conclusion that the carrier is financially capable and that the contract cost is reasonable—in other words, the plan sponsor must have no reason to believe the representations are false. The plan sponsor must also obtain updated written representations at least once a year.

The plan sponsor must determine that the cost of the annuity option is reasonable in relation to the benefits and features provided by the annuity. There is no requirement that the plan sponsor choose the least expensive annuity option.²

While this provision is expected to make it easier for plan sponsors to offer annuity options without fear of added fiduciary liability, the SECURE Act also makes the annuity portable once the plan participant has chosen the lifetime income option. Effective for tax years beginning after December 31, 2019, the annuity can be transferred in a direct trustee-to-trustee transfer between qualified plans (or between a qualified plan and an IRA) if the lifetime income option is removed from the original plan’s investment options.³ The option will be available to participants beginning 90 days prior to elimination of the annuity option from their current plan’s investment options (i.e., the portability window remains open for 90 days).⁴

In connection with the anticipated expansion of annuities within 401(k)s, the SECURE Act also aims to give clients more information that can allow them to evaluate how the annuity option could work for them. Defined contribution plans are now required to provide participants with lifetime income estimates. Plans must provide this statement at least annually even if the plan does not offer an annuity option.

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Planning Point: The DOL FAQ implement the interim final rule on the SECURE Act lifetime income illustration provisions. The FAQ clarifies that the earliest statement for which the illustrations are required is a statement for a quarter ending within 12 months of the rule’s effective date (i.e., September 18, 2021) if the plan issues quarterly statements. Therefore, the illustrations are timely if they were incorporated into any quarterly statement up to the second calendar quarter of 2022. For non-participant-directed plans, the lifetime income illustrations had to be included on the statement for the first plan year ending on or after September 19, 2021 (or, no later than October 15, 2022, which was the deadline for filing the annual return for a calendar year plan). The FAQ also clarifies that plans are permitted to provide additional lifetime income illustrations as long as the required illustrations are also provided, recognizing that some plans have been including illustrations for many years.

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The SECURE Act itself did not provide many details about what plan participants should expect. The DOL rule provides clarification.

Under the DOL interim final rule, released in August 2020, 401(k) plans and other ERISA-covered defined contribution plans must show plan participants the estimated monthly payment they could receive based upon their account balance and life expectancy. The plan must also provide the information based on the life expectancy of a participant and a spouse—even if the participant is unmarried—assuming the participant and spouse are the same age. The spousal information must be presented as a qualified joint and survivor annuity (QJSA).

In estimating the participant’s lifetime income stream, the plan must make certain assumptions. The information will assume that benefits begin at age 67 (or the participant’s actual age, if he or she has already reached age 67). The spousal benefit will be assumed to be 100 percent of the average monthly benefit during the time when both spouses are alive.

The plan must use the interest rate for specified 10-year constant-maturity Treasury securities and the IRC Section 417(e)(3)(B) unisex mortality tables must be used to determine life expectancies (this is the same table used for most defined benefit plan lump-sum distributions).

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Planning Point: Clients should be advised that the current rules do not require plans to factor in the client’s age or any potential future earnings on the account balance. Therefore, many clients will see numbers that are much lower than they could realistically expect to receive.

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If the plan actually offers annuities, the actual interest rates can be used, although the uniform assumptions about age upon benefit commencement, marital status, etc. must still be used.

Plans are also required to provide participants with certain explanations about all of this information. The DOL rule also contains model language that plans can use to satisfy their obligations and qualify for the fiduciary safe harbor with respect to annuity offerings.