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Treasury Rule Allows Split Between Annuities, Lump Sum

New Treasury rules could be a boon for annuities as an option within defined benefit plans, but only if agents and advisors get better at educating clients, experts say. 

The changes, announced in early September, simplify rules to allow retirees to simultaneously elect a partial lump sum and a partial annuity from a defined benefit pension plan.

Annuities are rarely offered in DB plans. Those plans that do include an annuity option see little participation in that option, but experts say better regulatory clarity will likely contribute to increased interest.

“This rule will provide pension plan participants with more flexibility when [they are] given the option of a lump sum or an annuity,” said Cathy Weatherford, president and CEO of the Insured Retirement Institute.

“It removes the all-or-nothing choice that these workers must make when given the option, and in doing so, it will hopefully encourage more Americans to take their benefit, at least in part, in the form of a lifetime income stream.”

The new rules apply to distributions with annuity payments starting in plan years beginning on or after Jan. 1, 2017. The rules are intended to encourage plans to offer hybrid distribution options that include an annuity, Treasury Department officials said.

Whether or not clients choose the annuity option could depend on the attention and education they receive from their agent/advisor, said Harold Evensky, professor of practice at Texas Tech University and chairman of Evensky & Katz/Foldes Financial Wealth Management.

“The ball is in our court basically,” he said. “As people sit down and if they begin to do some serious planning and they look to the numbers, I think people are going to realize that’s about the only way they’re going to come close to achieving their goal.”


Balancing Present and Future

First proposed in February 2012, the regulations are an attempt to balance retirees’ need for longevity insurance through partial annuity payments with the increased liquidity provided by lump sum payouts.

J. Mark Iwry, senior advisor to the Treasury secretary and deputy assistant secretary for retirement and health policy at the Treasury, spoke this summer about efforts to give retirees more lifetime income they can’t outgrow.

Too often, new retirees are only given a choice between lump sum, which most take, and rolling all the money into an annuity, Iwry said during an IRI conference in June.

In response to comments, tentative rules were streamlined to allow a participant’s accrued benefit to be bifurcated.

That means only the minimum present value requirements under the tax code will apply to the portion of the accrued benefit that is paid as a lump sum. Under the tax code, the minimum present value of a benefit offered by a pension plan cannot be less than the present value calculated by using a specified mortality table and interest rate.

The final rules allow two (rather than three) ways to split a benefit between a lump sum and an annuity, another change made in response to comments. Although some approaches appeared to fit very well with certain plan designs, some didn’t fit into any of the three, Treasury officials said.

Offering annuities is one hurdle. Their attractiveness as an investment depends on other hurdles, Evensky said. Obviously, advisors would like to see a better interest-rate environment.

“The payouts are very dependent on current rates, roughly the 10-year Treasury rate, which is historically extremely low,” he said.

On the other hand, advisors have a natural sale if they can help clients see the value in safety and peace of mind, Evensky explained.

“Any other investment gain is going to be from dividends, interest or capital gains,” he said. “An immediate annuity offers the potential for a mortality return, which can be an extraordinarily positive element, as well as the reality that it lasts for a lifetime.”


Administration Push

 Treasury wants to encourage more investment in annuities, Iwry has said. This is part of a general push by the Obama administration to prod Americans to save more for retirement.

Earlier this year, the administration rolled out the MyRA plan, which allows participants to save up to $15,000 for retirement, with no fees or risk of loss in principal. The funds are held in U.S. government debt, a safer alternative than stocks and corporate bonds.

In 2010, Obama signaled support for annuities when his Middle Class Task Force announced a series of policy proposals designed to aid middle-class families. Among them were a few initiatives for boosting retirement programs and savings, including specific language supporting annuities.

A July 2014 Treasury ruling allowed qualifying longevity annuity contracts (QLACs) within 401(k)s and individual retirement accounts. The rules allow qualified plan owners to divert some of their qualified assets into a QLAC, which is a type of deferred income annuity, up until age 85.

So far, they have been slow to take off, due in part to low interest rates and low education, Evensky said. The potential is there, however.

“It’s a much smaller chunk of someone’s nest egg, so I think it will be an extremely important vehicle in the next decade,” he said.

The Sept. 9 rules change came on the heels of a Government Accountability Office report that admonished the Department of Labor for not doing enough to encourage workers to consider lifetime income options. The report focused on workers who rely on their 401(k) plans to finance their retirement.

The GAO report came from responses from retirement plan administrators to a questionnaire. Those administrators represent more than 40 percent of all 401(k) assets and about a quarter of plans as of the end of 2014.

The GAO found that of the plans covered by the questionnaire, about two-thirds did not offer a withdrawal option — payments from accounts, sometimes designed to last a lifetime — and about three-quarters did not offer annuities, which are arrangements the GAO said can guarantee set payments for life.


InsuranceNewsNet Senior Editor John Hilton has covered business and other beats in more than 20 years of daily journalism. John may be reached at [email protected].


InsuranceNewsNet Senior Editor John Hilton has covered business and other beats in more than 20 years of daily journalism. Follow him on Twitter @INNJohnH. John may be reached at [email protected].

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