The Treasury Department and the Internal Revenue Service have issued guidance aimed at expanding the use of income annuities in 401(k) plans.
The guidance issued Friday in Notice 2014-66 makes clear that plan sponsors can include deferred income annuities in target date funds that are used as a default investment, in a manner that complies with plan qualification rules. The option is voluntary for plan sponsors and participants.
“As boomers approach retirement and life expectancies increase, income annuities can be an important planning tool for a secure retirement,” said J. Mark Iwry, senior advisor to the Secretary of the Treasury and Deputy Assistant Secretary for Retirement and Health Policy, in a statement. “Treasury is working to expand the availability of retirement income options for working families. By encouraging the use of income annuities, today’s guidance can help retirees protect themselves from outliving their savings.”
Many employer-sponsored 401(k) plans offer so-called target date funds as a default investment for participants who do not affirmatively elect a different investment. Target date funds get their name from the fact that their allocation of investments shifts gradually from equities to fixed income as participants approach an intended target retirement year.
A deferred income annuity provides an income stream that generally continues throughout an individual’s life but is not intended to begin until some time after it is purchased. This can provide a cost-effective solution for retirees willing to use part of their savings to protect against outliving the rest of their assets, and can also help them avoid overcompensating by unnecessarily limiting their spending in retirement.
The guidance provides plan sponsors with an additional option to make it easier for employees to consider using lifetime income. Instead of having to devote all of their account balance to annuities, employees use a portion of their savings to purchase guaranteed income for life while retaining other savings in other investments.
Under the guidance, a target date fund may include annuities allowing payments, beginning either immediately after retirement or at a later time, as part of its fixed income investments, even if the funds containing the annuities are limited to employees over a specified age. The guidance makes clear that plans have the option to offer target date funds that include such annuity contracts either as a default or as a regular investment alternative.
Notice 2014-66 provides a special rule that enables qualified defined contribution plans to provide lifetime income by offering, as investment options, a series of target date funds that include deferred annuities among their assets, even if some of the TDFs within the series are available only to older participants. This special rule provides that, if certain conditions are satisfied, a series of TDFs in a defined contribution plan is treated as a single right or feature for purposes of the nondiscrimination requirements of Section 401(a)(4) of the Tax Code. This permits the TDFs to satisfy those nondiscrimination requirements as they apply to rights or features even if one or more of the TDFs considered on its own would not satisfy those requirements.
In an accompanying letter, the Labor Department confirmed Friday that target date funds serving as default investment alternatives may include annuities among their fixed income investments. The letter also describes how ERISA fiduciary standards can be satisfied when a plan sponsor appoints an investment manager that selects the annuity contracts and annuity provider to pay the lifetime income.
In July, the Treasury Department and the IRS issued final rules on the use of longevity annuities—a type of deferred income annuity that begins at an advanced age—in 401(k) plans and IRAs as part of a broader coordinated effort with the Department of Labor to encourage lifetime income and enhance retirement security. Friday’s guidance is another step reflecting the continuing commitment of the Administration to work in a variety of ways to further bolster retirement security and saving.
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