Offer Guaranteed Retirement Income Within a 401(k) Plan (OPINION)

Pension plans are mostly history, and few participants in 401(k) plans know what their account balance will be when they retire.

But, thanks to new IRS and Treasury Department regulations announced in the Federal Register (Vol. 79, No. 127), a qualified longevity annuity contract (QLAC) is now allowable in qualified defined contribution plans, including 401(k), 403(b), 457 and IRA accounts.

An annuity is simply an agreement between a policy holder and an insurance company. If an employer allows its employees to purchase an annuity within their 401(k) plan, participants can move any or all of their account balance to the annuity.

Or, they may begin making payments into the contract as they would in a traditional 401(k) plan. Upon retirement, the insurance company returns money and interest earned over a timeframe determined by the holder. An annuity within a 401(k) plan isn’t entirely new, but the QLAC is and differs from a traditional annuity.

One significant difference is that QLAC contract owners may defer required minimum distributions until age 85. Another reason the QLAC is becoming significant is that third-party administrators (TPAs) are beginning to comply with employer requests to include annuities in mandated Form 5500 reporting. 

A TPA is employed to complete actuarial services. Data is collected monthly from plan custodians, summarized, and reported to the government annually. A fixed annuity held within a 401(k) plan requires an additional calculation because account values are determined annually.

An amenable TPA is needed to do the additional calculation. Interestingly, these TPA firms are generally more creative when designing plans so that smaller employers are utilizing options only larger companies have had available in the past.

When companies establish a traditional, one-size-fits-all plan to minimize complexities, they also may unknowingly minimize their tax-saving opportunities. For example, firms frequently miss the chance to use new comparability profit sharing plans when allocating dollars to key employees, cash-balance plans to defer and deduct contributions far in excess of current defined contribution limits, or double advantage safe harbor 401(k) plans.

To take advantage of these tax-saving opportunities, a company may need to change its TPA. Fortunately, this is not as burdensome as it may sound. Companies may change their TPA while continuing to use the same financial advisor and/or investment platform. So, if a company wants to add an annuity option to its 401(k) plan but continue to offer the same investments from the same advisors, it may do so.

Most 401(k) plans offer an array of mutual funds. Few plan participants know which choices to make when planning for retirement. If guaranteeing future retirement income is desirable, an annuity savings choice is like creating a personal pension within a 401(k) plan. A guaranteed monthly retirement income can be calculated at any time, if participants supply the amount funded into the contract and their age when they begin taking payments.

Another type of annuity available within a 401(k) plan is a fixed indexed annuity (FIA). Although a FIA won’t qualify as a QLAC and enjoy the age 85 required minimum distribution advantage, it can be designed for lifetime retirement income and risk-free savings accumulation. The annuity is portable, meaning it can be rolled into an IRA account when an employee retires or terminates his or her employment.

FIAs are a popular choice with 401(k) participants whose accounts were devastated by downturns in the past. All premiums paid into an FIA are safe from market downturns as are any earnings. FIAs enjoy safety from market risk, a rider offering guaranteed income for life, increased retirement income if unable to perform two of six activities of daily living, and distribution of unused account balances to beneficiaries without going through probate.

An annuity can be added as a choice in any defined contribution plan. It requires inclusion on Form 5500 of a company that wants to offer its employees a safe retirement alternative. The QLAC became eligible for inclusion in 401(k) plans last July. In the wake of pension plans, individuals can find solutions within their 401(k) plans.

Both QLACs and FIAs are 401(k) annuity options that offer guaranteed income in retirement and can never lose money due to market downturns. 

Dave Mersky is an investment advisor representative with Horter Investment Management and an independent insurance agent with The Change Agency LLC in Fayetteville. He can be reached at 479-42-8585 or [email protected].