By Anne Rosivach
The U.S. Treasury Department and the IRS have proposed an initial package of regulations and rulings that are intended to encourage retirees to invest some of the proceeds of their retirement accounts in annuities. Retirees have not shown interest in this type of investment because they are reluctant to invest their entire retirement account in an annuity, and they are not aware of other options, according to the Treasury Department. Investment advisors have mixed views on the value of annuities, saying that fees and interest rates can affect the income.
Proposed rules will reduce the administrative burden of a partial annuity so that retirement plans can more easily offer a partial annuity option. A second proposal will make a different kind of annuity, the so-called longevity annuity, more attractive to retirees by making a change in the minimum distribution requirement.
The new rules are in response to comments made in a request for information from the Departments of the Treasury and Labor on regulations for retirement accounts. The proposed guidance is expected to be followed by continued dialogue and further retirement income guidance from both the Treasury and Labor Departments later this year.
Partial annuity options
The partial annuity option allows individuals to take a portion of their plan benefits as a stream of regular monthly income payable for life and the remainder as a lump sum payment. This option has not been available in some defined benefit plans because of the complexity in calculating benefits.
The Treasury has proposed a change in regulation that will streamline the calculation of partial annuities, making it easier for defined benefit plans to include them in their offerings to retirees. The statutorily prescribed actuarial assumptions would be required to apply only to the portion of the distribution being paid as a lump sum. Plans would be allowed to determine the remainder of the benefit - the partial annuity - using the plan's regular conversion factors.
The longevity annuity allows retirees to use a limited portion of their savings to address the risk of outliving their assets by paying out a predictable income stream at a much later date than the normal retirement age, possibly starting at age 80 or 85. The advantage of the longevity annuity is that once the risk of outliving assets is addressed, a retiree's task of generating income from the remaining assets is more manageable because it is limited to a fixed period of time, according to the Treasury Department.
In general, longevity annuities have not been used much with 401(k) or other defined contribution plans or IRAs. A key reason for this is a regulatory obstacle posed by the minimum distribution requirement. Traditional IRAs and 401(k)s generally have tax-deferred contributions, so owners must take annual distributions starting at age 70 1/2 or over, according to the IRS.
The Treasury proposes giving special relief from the minimum distribution requirements for the longevity annuity: "Under the proposal, an annuity that costs no more than 25 percent of the account balance or (if less) $100,000 and that will begin by age 85 is disregarded in determining required minimum distributions before the annuity begins."
The longevity annuity would have to satisfy certain limits on cash-out options and death benefits in order to ensure that it is used only to protect against longevity risk (the risk of outliving one's assets) and to make it as cost-effective as possible, leaving more in the individual's account to live on before the annuity begins. The proposed regulations also would require individuals to be given full and clear disclosure of the terms of the annuity, the Treasury Department said.
Proposed guidance on existing related rules
The proposed administrative rulings clarify rules for plan rollovers to purchase annuities and spousal protections rules for 401(k) deferred annuities.
The proposed rulings give clarification on the rules that apply when employees are given the option to use a single-sum 401(k) payout to obtain a low-cost annuity from their employer's defined benefit pension plan. A second ruling clarifies that employers can offer their employees the option to use 401(k) savings to purchase deferred annuities and still satisfy spousal protection rules with minimal administrative burdens.