Champions of longevity annuities enjoyed a major victory this summer when the Department of Treasury issued guidance allowing their inclusion in 401(k) plans.
The question, however, of how readily qualified longevity annuity contracts will be adopted remains uncertain, according to partners with the Chicago-based law firm Thompson Coburn.
"The goal to help individuals maintain an income stream throughout the golden years is laudable," write firm partners Mark Weisberg and Linda Lemel Hoseman. But the final guidance issued by Treasury contain "numerous requirements and possible traps" that may slow sponsors' adoption and participants' understanding of the products.
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At the core of the Treasury's guidance was a provision that the premium paid to a qualified longevity annuity contract would be discounted against the overall value of a participant's 401(k) when it comes time to establish the required minimum distribution amount account holders are required to make when they reach 70 ½.
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QLACs can begin distributing income immediately upon retirement or later. Treasury has set the maximum age for the beginning of payments as the first day of the next month after the beneficiary's 85th birthday. That maximum age can be adjusted, if mortality rates rise.
That's all well and good, write Weisberg and Hoseman, but there are "many requirements imposed on a QLAC in order for it to receive the favorable treatment with respect to the minimum distribution calculations."
First, they say, the IRS has imposed a premium maximum, which can't exceed the lesser of 25 percent of the total plan's value, or $125,000.
And while the premium paid will be discounted in factoring the RMD, it will be included in total assets when determining the 25-percent maximum annuity premium.
Another important fact of life about QLACs: they cannot have a commutation benefit or cash surrender value. Simple enough, unless the named annuitant dies before the benefits have been paid out.
In that case, a lump sum can be paid to a named beneficiary, representing the amount of money left on the annuity. But it must be paid no later than "the end of the calendar year following the year of the death of the employee."
Recent surveys show annuity basics are lost on most retirement investors. With Treasury's guidance come new disclosure requirements insurers and sponsors will be strictly beholden to. If sponsors are to embrace QLACs, it probably won't be before a good deal of investments in participant education on the products.
Point being: there are a number of areas that sponsors may be prone to overlooking.
The IRS does provide for a limited period of correction in such cases, but the question of added complexity to plans in an era that has sponsors craving simplicity is one that may make them think twice before opening their plans to deferred annuities.
All of this helps explain this note of caution from the attorneys:
"Given all of these requirements and the overall complexity of explaining annuities generally to participants, it remains to be seen how quickly plan sponsors adopt these vehicles in their plans and even if they are permitted under the plan, how quickly participants embrace these products."
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Nick Thornton
Nick Thornton is a financial writer covering retirement and health care issues for BenefitsPRO and ALM Media. He greatly enjoys learning from the vast minds in the legal, academic, advisory and money management communities when covering the retirement space. He's also written on international marketing trends, financial institution risk management, defense and energy issues, the restaurant industry in New York City, surfing, cigars, rum, travel, and fishing. When not writing, he's pushing into some land or water.
