The SECURE Act and Guaranteed Retirement Income in Plans
By now you have probably seen a number of articles about the SECURE Act (Setting Every Community Up for Retirement Enhancement Act of 2019) and its safe harbor for guaranteed retirement income in 401(k) plans. Some have favored the safe harbor, while others have criticized it. In either case, the authors appear to contemplate that participants will be buying individual annuities at retail prices.
In my opinion, those articles—on both sides of the fight—are at best misleading and in some cases just plain wrong. I am writing this article to give you my views.
The SECURE Act has two requirements for including insured “guaranteed retirement income contracts” in plans. The first is that the plan fiduciaries (e.g., plan committees) consider “the financial capability of such insurer to satisfy its obligations” under the contract. In other words, the insurance company should be strong enough to pay the retirement income promised by the contracts. However, the legislation creates a safe harbor requiring only that certain information be obtained from the insurance companies. The fiduciaries don’t have to evaluate the information, just collect it. Needless to say that “checklist” approach will be easy to satisfy. But some mediocre, or even weak, insurance companies will be able to provide compliant information. (The checklist information is at the end of this article.)
The second requirement is that plan fiduciaries consider “the cost (including fees and commissions) of the guaranteed retirement income contract offered by the insurer in relation to the benefits and product features of the contract and administrative services to be provided under such contract” and determine that the cost is reasonable relative to those features and services. That’s harder to do. If this is treated the same as other fiduciary decisions, which I think it will be, plan fiduciaries must gather information about competing costs, features and services in order to decide if the arrangement is reasonable. And, of course, fiduciaries shouldn’t incur costs for contract features that aren’t valuable to the participants. I believe that plans will be expected to use their large pools of assets to get institutional-like pricing, much as is done for plan investments. I also think that plan committees will turn to their advisers for help in evaluating the costs and features.
On top of those considerations, for guaranteed retirement income contracts to get into 401(k) plans, they will need to be on record keepers’ platforms. While the checklist approach may allow some weak or mediocre insurance companies to qualify, I don’t think the record keepers (and certainly not the big record keepers) will allow those weak insurance companies onto their platforms. In many cases, the record keeping platforms are owned by major and highly rated insurance companies. I assume that their contracts will be on the platform, and if others will be allowed, they will be from similarly financially strong insurers. Why damage the brand by having weak products?
I also believe that the favored guarantees will not be individual annuities (fixed, fixed index or variable), but instead will be GMWBs—guaranteed minimum withdrawal benefits. The names of those products vary, but the concept is generally the same … a transparent charge (of 60 to 100 basis points per year) for a guarantee wrapped around a target date fund (or perhaps a balanced fund). The GMWB guarantees that as long as a retired participant doesn’t withdraw more than a certain amount per year (e.g., an amount equal to 5 percent of the high-water mark of the account value) the money will last for the life of the participant. Stated more accurately, the insurance company will step in and make the payments if the money runs out.
In my opinion, that is the most likely outcome. But to paraphrase Yogi Berra, it’s hard to make predictions, especially about the future. In any event, I don’t think the practical effect of the legislation will be to open the floodgates to individual retail annuity contracts or mediocre insurance companies.
Another possibility is to include “accumulation units” of annuities in target date (or balanced) asset allocation models in lieu of fixed-income or stable value. As with the target date fund (TDF)/GMWB arrangement, these models could qualify as QDIAs (qualified default investment alternatives) for participants who are defaulted into their investments for automatically enrolled plans. Of course, participants also could decide affirmatively to invest in them.
A third possibility is to have an annuity platform connected to a plan for participants to use when they take distributions, e.g., retire. I have heard from providers, though, that when given a short time to decide whether to use an annuity, most participants will take a lump-sum distribution or rollover of cash. Ultimately, plan sponsors, participants and record keepers will decide the outcome. But one way or another, the SECURE Act’s safe harbor will encourage offering guaranteed retirement income in plans.
The SECURE Act requires that plan fiduciaries obtain the following information (the “checklist”) about the financial conditions of insurers in order to obtain the benefit of the safe harbor:
A fiduciary will be deemed to satisfy the requirements…if—
(A) the fiduciary obtains written representations from the insurer that—
(i) the insurer is licensed to offer guaranteed retirement income contracts;
(ii) the insurer, at the time of selection and for each of the immediately preceding 7 plan years—
(I) operates under a certificate of authority from the insurance commissioner of its domiciliary State which has not been revoked or suspended;
(II) has filed audited financial statements in accordance with the laws of its domiciliary State under applicable statutory accounting principles;
(III) maintains (and has maintained) reserves which satisfies all the statutory requirements of all States where the insurer does business; and
(IV) is not operating under an order of supervision, rehabilitation, or liquidation;
(iii) the insurer undergoes, at least every 5 years, a financial examination (within the meaning of the law of its domiciliary State) by the insurance commissioner of the domiciliary State (or representative, designee, or other party approved by such commissioner); and
(iv) the insurer will notify the fiduciary of any change in circumstances occurring after the provision of the representations in clauses (i), (ii), and (iii) which would preclude the insurer from making such representations at the time of issuance of the guaranteed retirement income contract; and
(B) after receiving such representations and as of the time of selection, the fiduciary has not received any notice described in subparagraph (A)(iv) and is in possession of no other information which would cause the fiduciary to question the representations provided.