One of the lesser-known changes expected to follow the enactment of Secure Act 2.0 is a huge increase in the number of 401(k) plans that include annuities.
At least that’s the prediction of LIMRA, an association that represents more than 700 companies in the insurance and financial services industry. The group thinks the in-plan annuities market will grow exponentially over the next two years. That would not only provide more plan participants with guaranteed-income options but would also significantly impact financial advisors, considering that they set up 93% of retirement plans, LIMRA says.
Although annuities have been permitted in retirement plans for many years, few employers have included them. Various studies have shown that only 12% to 14% of 401(k) plans include an annuity option, said Bryan Hodgens, head of LIMRA distribution and annuity research, during a recent interview.
With fewer people having a traditional defined-benefit retirement plan and an unpredictable economy that’s featured rising inflation, it’s no surprise more are worried they will run out of money during retirement. In a Greenwald Research study released in January, 72% of retirement-plan participants said they need in-plan income to have a financially secure retirement.
Momentum has been building for in-plan annuities ever since Secure Act 1.0 was signed into law in late 2019 as part of the 2020 federal budget, Hodgens said. Before Secure Act 1.0, an employer — as a fiduciary — could be held liable if its workers lost money on an in-plan annuity from an insurance company that failed, he explained. Secure 1.0 created a new safe harbor for employers that simplifies how they must do due diligence on an insurer before including its guaranteed-income annuity in their retirement plans.
Secure Act 2.0, which President Biden signed into law December 29, made additional changes that will spur small businesses to create retirement plans, believes Hodgens. Plans are likely to grow larger because beginning in 2025, companies that sponsor new 401(k) or 403(b) plans must automatically enroll employees, unless they opt out, with an initial contribution of at least 3% that rises 1% a year for 10 years.
What will also make a difference is that Secure Act 2.0 allows people to buy larger annuities in their retirement plans. The act raised the maximum purchase for a qualified longevity annuity contract (QLAC) within a retirement plan to $200,000 from $125,000, Hodgens noted.
Secure Act 2.0 also changed the rules on how annuities affect required minimum distributions (RMDs), Hodgens said. Under existing IRS regulations, RMDs exclude the value of an annuity contract in a retirement account and are based on the remaining balance. However, the required withdrawal on that remaining balance is not reduced by annuity income, even if it results in a distribution higher than the RMD. Under Secure 2.0, the U.S. Treasury is rewriting regulations so the value of an annuity contract is treated as part of the account balance and annuity payments are applied toward the RMD.
“You were getting penalized … you were not getting the full credit of that income stream coming out of your annuity,” Hodgens said.
Another ongoing obstacle to annuities in retirement plans has been that few recordkeepers have included them on their platforms for plan sponsors. More recordkeepers have to invest in technology to offer annuities, Hodgens said, and that’s started to happen among the bigger ones.
Another step that needs to happen for annuities to be included in retirement plans is for advisors to learn more about the options. LIMRA research shows advisors need more knowledge about in-plan annuities. Three in 10 advisors believe guaranteed-income options need to be simplified so clients can better understand them.
Hodgens said financial consultants to larger plans have taken the lead in discussing annuities with clients. He said a Greenwald study shows that 63% have already met with their client investment committees to discuss the addition of a guaranteed-income product to their plan lineup.
Annuity options for retirement plans
Hodgens said the choices run the gamut. “I think we’ve seen some really interesting innovation occur, and this comes out of Secure 1.0,” he said.
One product strategy is to embed a guaranteed-income option, such as a fixed-rate deferred annuity, as part of a target-date fund. That becomes the fixed-income sleeve whose allocation grows as a person grows older, Hodgens said.
Another strategy is to include a standalone annuity in a retirement plan. “I’ve seen a lot of fixed indexed annuities here. In this category, you get some variable annuity contracts with guaranteed living benefits. But there’s no restriction on what can be included,” he said.
A third strategy is an out-of-plan option. In that scenario, a 401(k) plan would not include an annuity within the plan itself, he said. When a participant gets into, say, their mid-fifties, they are offered the chance to exchange some of their 401(k) balance for an annuity, he said. Fidelity, for example, offers that option.
Fees
Annuities within retirement plans have lower fees than retail ones because they are designed with institutional pricing, Hodgens said. “There are no commissions paid, as you would see in the retail world,” he said. “Now you add the liquidity aspect. There’s no waiting period. I don’t have to wait a term — five years or seven years — as you would on a retail product that would have some sort of contingent sales charge,” he said. “In theory, you can put your money into the annuity this month, your contribution inside the plan next month, and just like you can with a mutual fund, you can change your mind and reallocate those dollars into a different bucket. And you are not going to have to worry about any kind of surrender charges or waiting periods if you leave your employer.”
Like other investments within a 401(k) plan, the fees associated with an in-plan annuity will be embedded in the cost the employer pays for the plan. Those total fees can vary greatly, depending on the advisor, the work involved, the size of the plan and more, Hodgens said.
But what does the participant do with the annuity if they do leave their employer? The participant may be able to leave the annuity in their former employer’s plan or move it to their new company if its plan has the same annuity option, Hodgens said. The participant can also roll the annuity into a self-directed IRA if those other two options are unappealing or unavailable.
