DIAs in TDFs
Deferred Income or Longevity Annuities –
A Big Win for the Insurance Industry
On October 24, 2014 the US Department of Treasury and the Internal Revenue Service paved the way for 401(k) participants to accumulate a guaranteed income stream within a defined-contribution plan (DC).
This new guidance represents a big win for the life insurance industry. Why? Morningstar reports that “the retirement landscape has shifted investors from the predictable payments of defined-benefit plans to the relative uncertainty of saving for their own retirement via define-contribution plans.” Plan sponsors have wanted to offer the best of both worlds: provide guaranteed income, and also asset flexibility.
Now plan sponsors will be able to offer annuities in qualified default investments to workers aged 55 or older while being compliant with ERISA’s non-discrimination rules.
A Bit of Legislative History
Deferred income annuities delay payments of income, installments or a lump sum, until the investor decides to receive them. This type of annuity has two main phases: 1) the savings phase in which money is invested into the account; and 2) the income phase when the plan is converted into an annuity and payments are received. They differ from immediate annuities due to the delayed payment. After the Pension Protection Act of 2006 went into effect, the mutual fund industry tried to get target date funds (TDF) qualified as a default investment in DC plans, and the insurance industry was hoping for the same treatment to annuities. The TDFs won the legislation battle when they were named as a Qualified Default Investment Alternative (QDIA). Tower Watson research states that 86% of DC plans now use TDFs. Assets in them tripled between 2006 and 2012.
Industry Outlook on This Win
The Treasury’s guidance to support the use of deferred annuities in target-date funds is potentially momentous. It can do for the annuities what the Pension Protection Act did for TDFs. The Treasury received confirmation from the Department of Labor that target-date funds with deferred annuities still meet QDIA requirements, raising the potential for this new breed of target-date funds to reach a vast audience in relatively short order. The Treasury explicitly states that the Notice does not cover two specific solutions, namely target-date funds with a guaranteed lifetime withdrawal benefit or a guaranteed minimum withdrawal benefit. Investors in these solutions pay an explicit cost to an insurer in return for a guaranteed payment that continues even if they deplete their assets. The Treasury has not yet decided if it will provide guidance on these solutions.
Before annuities can become a staple in 401(k) plans, big plan sponsors must pave the way, evaluating potential alternatives as they come to market. The inclusion of insurers makes the process more complicated with product portability, fiduciary obligations, and recordkeeping concerns. Dave Blachett of Morningstar’s invest team, says “Once awareness and acceptance grows, the competition will become intense.” This will drive costs down, which addresses a core complaint that many have with the annuities in the retail market. It will also require further regulatory guidance. The DOL is expected to take up the Annuity Selection Rule next year.
Who knows when pre-retirees participants will see annuities in their TDF choices? We’ll have to wait and see how two industries who have historically competed against each other will work together.