Americans are living longer. From 1960 to 2016, the average American life expectancy¬†increased by nine years. Despite the increase in life expectancy, workers are retiring at the same age as they did in 1960. Yet, the landscape of retirement plans has changed, as the private sector has moved away from lifetime income annuities¬†and pensions, called ‚Äúdefined benefit‚ÄĚ plans. They now offer employer-sponsored 401(k) plans instead.
A majority of employer-sponsored plans are set up as defined contribution (DC) plans, meaning that unlike defined benefit plans where the benefit is defined¬†(usually a percentage of current income) a defined contribution (DC) plan defines the contribution¬†that can be made to the plan subject to IRS limits.¬†An employee can only withdraw what has accumulated in the plan and since typically the money is invested in the stock market, payments are not¬†guaranteed for both participant and survivor as under traditional pensions and annuities.
Unfortunately, these stiffer plans mean retirees must make their retirement savings last longer or risk outliving their savings. However, the House Ways and Means Committee is looking to change this bleak financial outlook.
Many plan sponsors avoid lifetime annuity offerings in their retirement plans in fear of lawsuits. Under the current law, plan participants who select a lifetime-income option that could later be discontinued by the plan sponsor can suffer from “surrender fees,” taxes or early distribution fees.
To avoid the risk associated with plan discontinuation, plan sponsors choose to offer only DC plans that are easily rolled into an IRA. Without lifetime annuity options, many 401(k) participants are left to manage their saving, and more importantly their distributions, on their own.
H.R. 88, the provision from outgoing House Ways and Means Committee Chairman Kevin Brady, would allow any participant to convert their retirement savings into a stream of income. Employees converting their retirements can avoid the hassle of manually withdrawing cash or rolling over their account balance into a separate annuity.
Brady’s provisions include other options that make retirement savings both more manageable and available for all workers. One requirement would let small employers join other employers in multi-employer retirement plans.
This provision gives retirement options to the oftentimes lowest-paid employees while allowing small employers the ability to offer a benefit not typically available to them. Another Brady provision would require plan sponsors to provide lifetime income illustrations to employees.
This lifetime-income disclosure grants transparency and planning abilities to employees regarding their retirement savings. Unfortunately for the Republican Brady, incoming Democrat Rep. Richard Neal, is expected to take over the chairman position in the House Ways and Means Committee.
However, this change in leadership does not mean that all proposed changes to retirement legislation are dead. Neal has proposed his own version of retirement regulation changes under H.R. 4524, titled “Retirement Plan Simplification and Enhancement Act of 2017.”
Neal’s bill proposes several changes to current retirement regulations. One of the most important provision regarding retirees outliving their savings is a lifetime income portability option. Under the portability option, participants can avoid early withdrawal penalties and taxes of a discontinued sponsored plan by moving their funds to another plan.
While it is common for employees to rollover funds from one employer to another, the provision adds an important component to current regulations. The receiving plan sponsor does not need to provide a lifetime income option for the employee to move the funds.
Essentially, this provision removes existing barriers for workers selecting a lifetime income investment.
While the proposed legislation appears to offer only good news to employees saving for retirement, some issues could arise if the legislation is passed. Life insurance agents and financial professionals will have to deal with a different retirement landscape.
The provisions could potentially lead to a reduction in the number of retirement plan rollovers that occur. Retirees who opt for lifetime income annuities will no longer need to shop for annuities at the time of retirement.
Rollovers into Individual Retirement Accounts (IRAs) and Individual Retirement Annuities¬†generate work and income for financial professionals. Also, life insurers could change their desired consumer, becoming more interested in courting plan sponsors who offer lifetime income provider needs and less interested in retirement savers and their financial advisors.
Although innocuous at first glance, the lifetime-income disclosure could bring about lawsuits while other provisions are trying to minimize risk. One concern is that if the disclosure projects more income than will be available, it will cause retirees to run out of savings regardless.
What is unknown at this time are the potential costs and fees that could be associated with the provisions. Changes like the provisions recommended could bring about hidden fees for plan sponsors as the regulations are implemented. While all the provisions are attempting to align with nine recommendations¬†to facilitate retirement health, potential industry impacts have yet to be uncovered.
This information is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.
Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Withdrawals made prior to age 59 ¬Ĺ are subject to a 10% IRS penalty tax and surrender charges may apply to annuity withdrawals. Guarantees are based on the claims paying ability of the issuing company.