Business of Benefits : Employee Benefits Lawyer & Attorney : Law Office of Robert J. Toth, Jr. : 403(b) Plans, Annuity & Insurance Law : Business of Benefits Blog

A couple of months ago, I began writing about the fiduciary concerns related to the purchase of annuities as distributions from  individual account DC plans. In that Part 1, I noted that there are five elements, so called "I's", which need to be addressed by any plan annuity. In that blog I focused on  "irrevocably", the fiduciary risk of what I called the "30 year risk"-on how one gets comfortable with the inherent risk of an insurance company failing over an annuitant's lifetime.

Inflexibility and Inaccessibility

 These two "I's" are closely related, as they really point out the nature of annuity products which are purchased for annuitztion from DC plans: they are plan investments. Treating them otherwise risks turning the DC plan into a DB plan, the ultimate disaster for this kind of program. So the fiduciary focus should be on how to address these elements in choosing annuities as investments under the plan.

Lets talk about what the fiduciaries need to deal with, and about what I mean when I say say irrevocable and inflexible. Traditional annuities are inflexible. Period. You get the monthly benefit you pay for. They provide a very valuable benefit which should be part of anyone's retirement planning, but this inflexibility can be scary, as it takes away from the participant the ability to address unexpected contingencies. This fear comes from the second point: the funds used to buy the traditional annuity are gone for good. Other than payments made under a survivor annuity, the traditional annuity doesn't give the participant any access to funds to pay for contingencies, nor does it typically pay a death benefit. So what's a fiduciary to do?

It's a plan investment. Unlike a DB plan, Including the annuity in a DC plan is a fiduciary decision-not a settlor function. So plug something like this into the normal fiduciary process:

1.  Decide whether you really want this sort of traditional annuity within the plan, and whether you want to limit the purchase to a portion of the participant's account balance. Check with the annuity company. There are number companies that have a variety of features which address these issues: some have death benefits; some are "cashable," having some sort of surrender benefit; some have a guaranteed payment over time.
2. Check for annuity purchase rates. Though "fees" are the typical focus of fiduciaries, that's not not the proper inquiry for these sorts of annuities-it really is all about seeing how much benefit can be purchased for what price. Check commissions.
3. Make sure the annuity is designed for a retirement plan: make sure there are unisex mortality; that it can do the proper Schedule A reporting; that there can be appropriate valuation; and if there's a death benefit, the incidental benefit rules are met. Depending on the type of contract and features, there may be a couple of more things to check out.
4. Decide whether to hold the annuity in the plan and pay the benefit out from the plan; or issue the annuity from the plan as a plan distributed annuity. If distributing, make sure the plan document permits in-kind distributions.
5. Review the range of variable and living benefits that may be available, where, inflexibility and inaccessibility are not a problem.
6. If allowing participants a choice of annuities, if an advisor is used, and any of products are registered products, make sure the advisor follows FINRA's suitability rules.

Of course, check out the insurance company (see Part 1).

Next up: Invisibilty: the sale/advising side of annuities

Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.  

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The mantra of Congress, investment advisors and the DOL over the past decade has been consistent: retirement plan assets must be invested in such a way to provide American workers with sufficient assets upon which to actually retire comfortably. This is as basic as apple pie, and a concept with which one can hardly disagree. It has even been the driving force behind regulatory efforts like the QDIA regs, where stable value or insurance investment options were openly scorned as appropriate default investment options.

As laudable as these efforts have been in the past, and as sound as they still may be, encouraging investment gain for the purpose of providing adequate retirement gain is NOT and has NEVER been the standard by which fiduciaries are judged.

ERISA Section 404(a)(1)(b) is written pretty clearly:

...a fiduciary shall discharge his duties.... by diversifying the investments of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly imprudent to do so."

There is no talk of maximizing gain. There is no language about providing any particular level of income. There is nothing about testing to see what level of return is needed to maintain a lifestyle. There is no discussion of age based target funds. It is truly based upon the concept of preserving the assets of the trust. 

It is important to re-find this lost concept, particularly as fiduciaries review their investment policies to test whether they are adequate under the current market conditions. This is not an argument against the use of equities, merely that the manner in which one fulfills the duty to minimize large loss necessarily includes investments designed to preserve capital.

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