Legislative, Regulatory Changes Can Better Prepare Workers for Retirement

The retirement income crisis threatens the long-term financial health of the United States. Some 77 million baby boomers will leave the workforce over the next 20 years, millions of whom are inadequately prepared for a lengthy retirement. Unless policymakers act quickly, the nation faces a significant risk that a substantial number of retirees will have inadequate income to meet their basic needs and will look to the government for massive assistance.

A key to avoiding this potential economic and social nightmare is to establish new rules and regulations that will encourage today’s near retirees and other workers to plan better for their post-working lives and to convert a portion of their retirement assets into lifetime income annuities. As documented in ACLI’s earlier BNA Insights article (102 PBD, 5/28/10; 37 BPR 1318, 6/8/10), employers and employees are partners in building American workers’ retirement security. A survey shows that employees want their employers to provide information about how their defined contribution plan assets translate into a guaranteed monthly stream of payments. Employees also say they want their employers to offer lifetime annuities as a plan distribution option. ¹ACLI Retirement Choices Study, Online Survey with Near-Retiree Defined Contribution Plan Participants, Mathew Greenwald & Associates, April 2010.

Initiatives now pending in Congress would make it easier for employers to provide highly-valued information and options to defined contribution plan participants. This BNA Insights article explores the nuts-and-bolts of these initiatives and discusses how, taken together, they offer a realistic and achievable program that can help alleviate the retirement income crisis.

Request for Information

For many years, Congress has examined proposals to create incentives for retirees to convert a portion of their retirement savings into lifetime annuities. ²See, e.g,, Secure Annuity Income for Life Act of 2003 (H.R. 2458), introduced June 12, 2003, http://thomas.loc.gov/cgi-bin/query/z?c108:H.R.2458:. However, the debate gained new momentum on Feb. 2, 2010, when the Labor and Treasury Departments issued a joint Request for Information (20 PBD, 2/2/10) (RFI) on lifetime income options for participants and beneficiaries in retirement plans. ³Request for Information Regarding Lifetime Income Options for Participants and Beneficiaries in Retirement Plans; Department of the Treasury and Department of Labor; Federal Register, Vol. 75, No. 21, Feb. 2, 2010, pps 5253-5258.

Briefly, the RFI notes the trend away from defined benefit plans in favor of defined contribution plans. “The number of active participants in defined benefit plans fell from about 27 million in 1975 to approximately 20 million in 2006, whereas the number of active participants in defined contribution plans increased from about 11 million in 1975 to 66 million in 2006.” ⁴Id. at 5253-5254.

As a result, the RFI says, employees “are not only increasingly responsible for the adequacy of their savings, but also for insuring that their savings last throughout retirement and, in many cases, the remaining lifetimes of their spouses and dependents.” ⁵Id. at 5254. Labor and Treasury asked for input on what steps, if any, they could or should take to enhance the retirement security of participants in retirement plans by facilitating access to arrangements that provide a lifetime income stream after retirement.

ACLI believes that a combination of enhanced education efforts, reduced burdens on employers and targeted incentives can establish the framework for a significant improvement in lifetime financial security for participants in defined contribution plans.

Enhanced Education, Information

For most working Americans, $100,000 probably seems like a substantial retirement nest egg. However, it is important for Americans to understand how that, or any sum, translates into a monthly stream of guaranteed income and thus how it will, in combination with Social Security, address their month-to-month expenses: housing, food, utilities, etc.

According to the federal government’s Thrift Savings Plan annuity calculator, $100,000 invested in a basic lifetime annuity at age 65 at current annuity rates would return $639 every month for the life of the retiree. ⁶TSP Annuity Calculator, http://www.tsp.gov/calc/annuity/calcAnnuityResults.cfm. This information is vital for effective retirement planning, yet most retirement plans provide participants solely with lump sum values. Legislation calling for defined contribution plan benefit statements to include an illustration of monthly guaranteed lifetime income has already been introduced in the 111^th Congress. ⁷Lifetime Income Disclosure Act (S. 2832), introduced Dec. 3, 2009 (230 PBD, 12/4/09;36 BPR 2766, 12/8/09), http://thomas.loc.gov/cgi-bin/query/z?c111:S.2832:; SAVE Act of 2009 (H.R. 4742), introduced March 3, 2010, http://thomas.loc.gov/cgi-bin/query/z?c111:H.R.4742:. ACLI supports this legislation. With this foundation of knowledge, participants can make better decisions about how much of their income to devote to defined contribution plans, when they can retire, and how they may have to manage their income to meet their lifestyle needs in retirement. Indeed, in a recent survey of workers nearing retirement age, more than 60 percent of respondents said they would likely devote more money to retirement savings if this illustration showed they would not have enough income to meet their needs. ⁸Op. cit., ACLI Retirement Choices Study.

Similarly, participants need information from their employers on post-retirement account management. Currently, DOL Interpretive Bulletin 96-1 focuses on the educational information plan administrators can offer participants regarding plan investments. ⁹Interpretive bulletin relating to participant investment education, 29 CFR 2509.96-1, http://www.dol.gov/dol/allcfr/title_29/part_2509/29CFR2509.96-1.htm. Employers need guidance on the other half of the retirement security equation, retirement distribution. DOL should provide guidance to address education on guaranteed lifetime income and other distribution options, both “in-plan” and outside the plan.

In addition, Treasury should modify the §402(f) rollover notice requirements ¹⁰26 USC 402, and the safe harbor notice ¹¹IRB 2009-39, http://www.irs.gov/irb/2009-39_IRB/ar14.html. to include information on lifetime income, including the availability of lifetime income plan distribution options, both inside the plan and outside.

Administrative Burdens/Ambiguities

The objective of expanding the availability of lifetime distribution options cannot be achieved without added burdens for employers. Employers already face numerous economic pressures in the employee benefits arena. Imposing additional administrative burdens on employers, or forcing them to navigate an ambiguous regulatory landscape, will dissuade employers from offering employees benefits such as retirement plans, especially in these difficult economic times.

It is essential to ease these burdens in the area of selecting providers of annuities and other guaranteed lifetime income options. Indeed, the duties facing employers should be similar to those in selecting providers of life insurance or disability income insurance. DOL took an important first step with the Selection of Annuity Providers regulation (194 PBD, 10/7/08; 35 BPR 2328, 10/14/08). ¹²29 CFR 2559.404a-4. This safe harbor provides helpful guideposts for employers in the selection of annuity providers. These include a requirement that employers engage in an objective, thorough and analytical search, conduct a cost-benefit analysis and consult with an appropriate expert, if necessary.

However, the rule also requires that the fiduciary “conclude that the annuity provider is financially able to make all future payments.” Since it is difficult to know how to draw that conclusion, the standard is ambiguous.

Modest changes to the rule can make it easier for employers to meet their prudential duties. For example, instead of a determination about the financial ability of the annuity provider to make all future payments, the safe harbor should require the fiduciary to give consideration to the financial strength and other “quality” aspects of the provider.

One such quality aspect is the strict state insurance regulation system that protects the solvency of life insurance companies. State insurance departments, in partnership with the National Association of Insurance Commissioners, establish and oversee rules for reserves, valuation of assets and liabilities, risk-based capital requirements and required capital. Insurance departments regularly review the financial strength of insurance companies and have authority to intervene to protect policyholders when capital and reserves fall below established guidelines.

Another avenue is to ease employers’ administrative burdens in the rules for qualified joint and survivor annuities, which are an important part of retirement plans. ¹³Retirement Topics-Qualified Joint and Survivor Annuity, Internal Revenue Service, last updated August 5, 2009, http://www.irs.gov/retirement/participant/article/0,,id=211555,00.html. This includes developing model amendments for guaranteed lifetime income options, model employee notices to satisfy the notice requirements and allowing for the use of electronic signatures.

ACLI proposes allowing employers, at their option, to transfer the duties and liabilities of administering qualified and joint survivor annuity rules to an annuity administrator. ACLI also urges Treasury to issue guidance that a participant’s purchase of incremental deferred payout annuities should not be subject to the qualified and joint survivor annuity rules until the participant has elected to take the annuity payout.

Incentives

Just as the barriers facing employers must be addressed, so to should Congress and the administration explore ways to encourage employees to elect to use a portion of their savings to obtain guaranteed lifetime income vehicles.

The Obama administration has already proposed a major step towards this goal by supporting a change in the tax code to permit partial annuitization of a nonqualified annuity contract. ¹⁴General Explanations of the Administration’s Fiscal Year 2011 Revenue Proposals (Green Book), Page 74, http://www.treas.gov/offices/tax-policy/library/greenbk10.pdf. For qualified arrangements, Labor and Treasury should provide guidance clarifying that plans may provide for using a portion of the account value to purchase an annuity or guaranteed lifetime income. Simplifying annuitization is vital to helping Americans plan for retirement.

Another important way to encourage employees to consider lifetime income products is to facilitate the use of longevity insurance. Longevity insurance is a deferred lifetime income annuity that usually begins to pay benefits when the annuity owner reaches age 85. Unfortunately current required minimum distribution (RMD) rules under tax code Section 401(a)(9) frustrate the use of longevity insurance in plans as premiums paid by retirees are included in the calculation of RMD. ¹⁵26 USC 401(a)(9).

ACLI supports legislation that would facilitate the use of longevity insurance by excluding the premiums paid from the RMD calculation. ¹⁶Retirement Security Needs Lifetime Pay Act (H.R. 2748), introduced June 8, 2009, http://thomas.loc.gov/cgi-bin/query/z?c111:H.R.2748:. Since the RMD rules apply only to qualified retirement savings vehicles, this change would encourage plan participants and IRA owners to use a portion of their account balances to purchase longevity insurance.

Finally, ACLI supports a limited and carefully-targeted tax incentive to encourage the use of guaranteed lifetime income. Currently, guaranteed lifetime income is treated the same as a single sum distribution; that is, it is taxable as ordinary income. A limited tax incentive to encourage individuals to annuitize a portion of their retirement savings would help spur true lifetime financial security.

Advantages for Employers

Loyalty of experienced and highly-trained employees is becoming an increasingly rare commodity in today’s workforce. Just 14 years ago, in February 1996, the average American worker aged 45 to 54 had been with his or her current employer for 8.3 years. By January 2008, the tenure for workers in this category dropped to 7.6 years. ¹⁷Median years of tenure with current employer for employed wage and salary workers by age and sex, selected years 1996-2008, Bureau of Labor Statistics, Economic News Release, Sept. 26, 2008, http://www.bls.gov/news.release/tenure.t01.htm.

Providing employees with lifetime income retirement options may help reverse that trend. Lifetime income options may help attract and retain quality employees by giving them access to a defined benefit-type option at a time when such plans are rarely offered. Moreover, a lifetime income option will help employers prepare their employees for retirement by providing the resources employees need to make and implement a retirement income strategy.

Unfortunately, concerns about increased fiduciary responsibilities and potential liabilities involving the selection of annuity providers deter many employers from including annuity options in their retirement plans. The modest steps outlined above will encourage employers to include lifetime income options in their plans without increasing their administrative burdens or their liability exposure.

Conclusion

There is perhaps no greater long-term threat to the economic well-being of Americans than the retirement income crisis. As documented in the first installment of ACLI’s contribution to BNA Insights, the baby boom generation is woefully unprepared for a retirement that could last 30 years or more. ¹⁸Keating, Frank, Policymakers Can Help Retirees Achieve Lifetime Financial Security, BNA Insights, Pension & Benefits Daily, May 28, 2010. Retirement savings are too low and many workers adopt distribution strategies that leave them exposed to a substantial risk of outliving their assets.

They may well become a significant burden either on their families or the next generation of American taxpayers unless policymakers both on Capitol Hill and the administration take action quickly to encourage retirement savings and effective retirement planning.

The Labor/Treasury RFI represents an important milestone. For too long, the looming demographic time bomb has been ignored by policymakers or placed on the back burner while other, seemingly more pressing economic issues were given priority. And naturally, the longer the problem was ignored, the worse it got. The RFI, issued while America still grappled with a major financial meltdown, shows that retirement planning and lifetime income needs are moving towards the center of national policy.

The steps advocated by ACLI will not address the entire retirement crisis. Much more needs to be done to encourage workers to save, and save aggressively, for retirement. But the policy agenda advocated above will help employees visualize and understand their income needs for when their working days are over, encourage better retirement planning and provide better access to products that can guarantee lifetime income.

With the baby boom generation now at the cusp of retirement, the problem cannot be ignored any longer.