By raising the standard on advisors recommending IRA rollovers to a fiduciary level of care, the Department of Labor’s fiduciary rule may restrict assets in 401(k) plans from flowing to IRA accounts, according to the latest edition of the Cerulli Edge, published by global analytics firm Cerulli Associates.

While the Boston-based firm “strongly agrees” with the intention to raise financial advisors’ standard of care and protect retirement investors from conflicts of interest, the rule’s implicit belief that employer-sponsored plans are the optimal place for retirement savers may have unintended consequences as investors seek to convert accumulated savings to income in retirement.

“The limitations of the defined contribution platform prevent it from being a suitable vehicle for (retirement) income,” analysts at Cerulli write.

For the purposes of generating an income strategy in retirement, IRAs are “more flexible” platforms, say the analysts.

“Beyond the DOL Conflict of Interest Rule, the collective effect of the policy action around the defined contribution space suggests a tacit endorsement for leaving assets in-plan,” explained Bing Waldert, managing director of U.S. research at Cerulli, in an email.

While 401(k) participants, particularly those in large plans, tend to have access to cheaper share classes and institutional pricing on investments not available to IRA investors, structural restrictions, and the limited adoption of in-plan income products such as annuities, make defined contribution plans unsuitable for creating decumulation and income distribution strategies, said Waldert.

Flexibility wanted

In potentially encouraging more assets to stay in plan and retain access to lower fees on investments, the DOL rule “has gotten ahead of what the current reality is,” Waldert told BenefitsPro.

He said Cerulli’s research shows the feature investors most want from retirement plans is the ability to take withdrawals as needed.

“Retirees want the flexibility to take distributions for unexpected health expenses, vacations, other one-time expenses, etc., beyond periodic or monthly distributions,” said Waldert.

But few plans give retirees that level of access to their assets. Waldert cited research from Vanguard that shows only 10 percent of 401(k) plans allow for “ad hoc” withdrawals.

“Until distribution options improve, it is difficult to see DC plans as a viable decumulation vehicle,” he added.

Despite guidance issued by the IRS and Labor Department in 2014 clarifying that plan sponsors would not be responsible for the selection of annuity providers whose products are built into target date funds, sponsors have been slow to adopt in-plan annuity options.

They tend to be reluctant to be among the first to implement annuity strategies, creating a “chicken and egg” scenario in which no sponsor will implement annuities until all do, wrote analysts in June’s edition of Cerulli Edge.

“Large plan sponsors are painfully aware that they will not be rewarded as an early adopter — rather, they are more focused on minimizing risk of litigation,” according to the report.

'Regulators need to get moving on the safe harbor stuff'

Waldert said that there is still sentiment among sponsors that annuity safe harbor regulations need to be further addressed.

That sentiment was underscored in conversations with three leading annuity and plan providers before the Labor Department rule was finalized.

While the consensus among providers was that sponsors are showing more interest in considering adopting annuities in plan, a clearer understanding of their fiduciary obligations, and liabilities, in adding annuities in-plan is needed from Washington.

“Sponsors are all ears and open to the concept, but the absence of clear safe harbors remain the biggest challenge,” said Jerry Patterson, senior vice president of retirement and investor services at Principal Financial Group, which is based in Des Moines, Iowa.

“We’re at an inflection point — more people are entering retirement, fewer have defined benefit pension plans, and health care costs are expected to go up,” said Patterson. “The role of guaranteed income is a compelling argument, and sponsors realize that.”

Patterson says Principal Financial has been engaged “intensely” with regulators in Washington. The good news, he says, is that they are not running into skepticism from the Labor Department or IRS.

But they have had a full agenda, dominated by the Labor Department's fiduciary rule. One consequence of its finalization is that the Labor Department can now redirect more energy to addressing in-plan annuity safe harbors, thinks Patterson.

Even with clearer safe harbors, sponsors will have to commit to educating participants on the value of annuitizing some portion of their savings, which will be a “tall task,” says Patterson.

“We don’t underestimate how important it is to get the education piece of this right,” said Patterson. “Our research shows that people don’t know a lot about annuities, but when they are described, they are attracted to them. Communicating the value proposition of annuities is as important as the product itself.”

Last October, the Principal Financial rolled out an annuity platform — Pension Builder — that can be added to existing 401(k) menus. Since the rollout, the firm continues to invest in interactive education tools to facilitate wider adoption.

But the key to delivering annuities value will be clearer oversight from DOL and IRS. “Regulators really need to get moving on the safe harbor stuff,” said Patterson.

A hedge against volatility

Srinivas Reddy, head of full-service investments at Prudential, which began offering in-plan annuities in 2007, says designing simple, understandable products is necessary to expand penetration.

In the retail market, investors have the advantage of tapping an advisor’s expertise. That of course comes at a cost, notes Reddy.

But in-plan annuities have unique advantages for investors that can’t be accessed through retail channels, says Reddy.

“For retirement savers, annuities though 401(k) plans will be more affordable, and when sponsors are adopting them, participants have the security of their employer’s fiduciary obligations to know they are getting the best product.”

Reddy says annuities’ value as a hedge against market volatility for those nearing retirement is instrumental to their overall value proposition. He sites the case of participants that were forced to delay retirement in the wake of the financial crisis, after seeing dramatic losses in their 401(k) accounts.

“Our products are designed for participants to take advantage of up to 10 years before their retirement,” he said. “Those with more time can recover from potential market shocks.”

When sponsors offer annuities as part of a qualified default investment alternative, as in a target-date fund, Reddy said, Prudential sees uptake of up to 30 percent in some plans. Adoption tends to be much lower when they are offered as a stand-alone option, he said.

Best of both worlds for sponsors

Roberta Rafaloff, vice president of MetLife’s institutional income division, underscored the necessity of simplicity in offering annuity products to 401(k) participants.

MetLife has been offering in-plan annuities for 40 years. The decline in defined benefit plans fueled early demand for the product. But these days, Rafaloff says more sponsors understand they play a heightened role in helping employees achieve retirement security.

At the same time, evidence is emerging that more sponsors want separating participants to leave money in plan when they retire.

“We understand why some sponsors would want to keep more assets in plan, but there is still the question of managing participants’ longevity risk,” said Rafaloff.

“In offering annuities and partially annuitizing savings, sponsors can address participants’ longevity risk, and still keep some assets in plan — it’s the best of both worlds for sponsors,” she said.