The SECURE Act
President Trump signed the SECURE Act (Setting Every Community Up for Retirement Enhancement) into law on Dec. 20, 2019, to promote better access to retirement income within the 401(k) market. One of the highlights of the act was to make it safer for employers to include annuities in their 401(k) plans. Previously, employers were hesitant to use annuities in the plan because of the high-level of legal liability risk. The Secure Act’s safe harbor provision relaxes the fiduciary responsibility of plan sponsors when choosing an annuity provider.
An annuity is an insurance contract that provides a fixed income stream for a fixed period or a person’s remaining lifetime. It can be viewed as an additional benefit to employees for protection against economic uncertainty, particularly during retirement.
An individual annuity can be purchased with a lump sum or a series of payments. The annuity can begin paying out almost immediately or sometime in the future. An annuity also can be used to leave money to beneficiaries. Some annuities can also be used to help pay for long-term care.
With a deferred annuity, the participants pay an insurance premium which will grow tax-deferred throughout the annuity’s accumulation phase, typically 10 to 30 years. After that, once the distribution phase starts, the participant begins receiving regular payments.
While, the insurance company makes money by charging fees for investment management, contract riders and other administrative services, the annuity owner is protected from the possibility of outliving their money. If the annuity owner takes the money out early, they will have to pay a surrender charge. Plus, insurance companies impose caps, spreads and participation rates on indexed annuities which can reduce the amount of money the policy owner gets back.
If the annuity was purchased with after-tax money, only the earnings will be taxed when the money is withdrawn.
Known as the personal pension, the 403(b) plan offers tax-advantaged retirement saving for employees in the non-profit or government sectors. These plans have had in plan annuities for decades. Employees contribute to an annuity throughout their employment. Both 403(b) and 401(k) participants can purchase an annuity using their accumulated retirement savings. But contributing to an in-plan annuity has advantages, including no riders; lower fees than if a retiree buys an immediate annuity; and higher returns and reduced interest rate risk.
The Secure Act added a safe harbor provision for the selection and use of annuity products underwritten by insurance companies. This provision was added to the Employee Retirement Income Security Act (ERISA). The safe harbor provides a plan sponsor with immunity from legal action should the insurer become insolvent. To qualify, the plan sponsor must select an annuity carrier with the following attributes as outlined in Section 204(2):
- It must be licensed to offer guaranteed retirement income contracts
- At the time of selection and for each of the preceding seven years, it:
- Was/is operating under a certificate of authority from its domiciliary state
- Filed audited statutory financial statements
- Maintains reserves which satisfy statutory requirements
- Was/Is not under an order of supervision, rehabilitation, or liquidation.
- It undergoes a financial examination by its domiciliary state at least every five years.
Experts recommend that in order to choose the best investment option for embedding an in-plan annuity, an employer should consider these two steps:
- Establish a Compliant Insurer Selection Process, as defined by the safe harbor in the Secure Act legislation
- Identify several acceptable carriers, then establish a compliant product selection process to choose the best program.
Annuities are still rare in 401(k) plans. Willis Towers Watson reports that only about 5% of 401(k) plans provide an in-plan annuity option. The Secure Act was supposed to change that, but the onset of the global pandemic in early 2020 acted as a brake on new initiatives, along with long standing reluctance of plan sponsors to introduce retirement income solutions.
This may be changing. Numerous ne plans have been launched. But employers should proceed with caution. A guaranteed lifetime income option shouldn’t be the only product in a retirement plan. A retirement portfolio should be diversified. Experts recommend directing only a portion — for instance 20% of retirement plan contributions to an annuity. This allows plan participants to take advantage of more aggressive growth opportunities while building a source of guaranteed income during their retirement years.
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