Well, technically, we didn’t write this idea on the beer napkin, but the thought occurred to us to do so as David John and I were sitting in a restaurant at Union Station quaffing one or two. The beer napkin was too wet to write on, but here’s the idea as best I remember it. Lets call it the Beer Napkin Annuity.
As many folks work to answer the IRS’/DOL’s RFI, one thing is clearly coming out: there is a LOT of resistance to mandatory annuitzation of 401(k) account balances. I can’t say that I really disagree with that resistance. Heck, I saved that money, didn’t I? But what should we do to address the fact that account balances run out? We continue to hear of "Pension Envy" against those fortunate few who are eligible for those steady, comforting monthly DB benefits.
Traditionally, the tax system was designed so that an employee can have the full, intended retirement plan benefit by an employer maintaining BOTH a DB and a DC plan. The benefit from each plan is limited (generally a $195,000 per year payment from the DB for 2010, and a $49,000 plus a 5k "old guy catch-up" for DC plans. In reality the limits get a whole lot more complicated in application, particularly when combined with other plans). These two limits were one time coordinated, so you couldn’t get the max out of each plan. But this coordination was repealed in 1996. This means that employees can max out in both plans (up to the employer’s deduction limit) if the employer chose to offer them. And many did. Now, for a variety of reasons (many upon which I have blogged), employers have been dumping the DB; trying to goose the DC plans; or trying to turn their DB plans in DC plans via the inartful effort of the Cash Balance Plan.
So, we have been talking much lately about annuitizing that account balance in the DC plan to make up for the loss of this lifetime guarantee. But one of the biggest problems with DC annuitization as a replacement for DBs is that we are still stuck with a single, DC 415 limit-the DB limit is left unused.
The funny thing about DB plans is that the benefits from these plans are expected and intended to come out as monthly payments, not as a lump sum (though DB plans have been dramatically amended in the last few years to provide lump sum benefits). And no one complains about this sort of "mandatory" annuitization.
So it it occurred to me: why not permit the use of the existing DB limit (or its actuarial equivalent) to be used in a DC plan, to the extent that a lifetime guarantee program is purchased with that additional limit. It can be used by the employer to make contributions to either the DB or DC side, or both, as long as a lifetime guarantee is purchased. I can see a portion of an employer match going into the DB like program (perhaps as a "safe harbor" contribution which relieves the discrimination testing on the DC side); maintaining the employees’ right to access and invest their own elective deferrals; while allowing participants to take any portion of their DC account balance and purchase additional lifetime guarantees under that "DB limit" program.
The DB portion would be fashioned as a DC contribution, and the benefit coming out being treated as a payment from the investment under the plan. This prevents turning the DC plan into a DB plan. You see, as much as I love DB plans, they have has this nasty side-effect of turning a widget maker into an insurance company. This program avoids that, and would require that this" DB-like" guarantee be fully funded upon purchase by use of an "investment" annuity product in the marketplace. Alternatively, I guess, it could be fashioned as an insured pension plan under the existing 412(i) rules-which contemplates level premiums paid to an individual contract for level payments guaranteed over a lifetime.
It’d take a little bit to figure out the rules, but heck. It uses a tax benefit currently on the books in a way for which it was intended, and could be implemented relatively simply in the current regulatory scheme. It uses a concept folks have accepted and are used to: a DB benefit is paid in a monthly payment, but I (that is the participant) still get to invest my own money (ie, 401k elective deferrals) as I want.
The Beer Napkin Annuity……
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