Lifetime Income for 401(k) plans has been been getting a lot of press, driven in large part by efforts by the DOL and Treasury to find ways to promote retirement security.
The IRS took a substantial step in making these DC lifetime income efforts become a reality with its publication of the final regulations establishing the “Qualified Plan Longevity Annuity Contract,” or “QLAC “. In order to even publish this regulation, however, the IRS had to “clear the underbrush” and resolve an number of technical issues relating to the manner in which defined contribution plans could even provide lifetime income.
Treasury and IRS staff did just this, and quite practically. The final regs even addressed some key market concerns, removing a couple of roadblocks which would have made the QLACs difficult to provide. So, for example, the QLAC can have a return of premium feature; can pay certain gains (which is important for certain, popular, annuity products); removed potentially duplicative disclosure requirements; and permits insurance companies to use off the shelf annuity products without amending them (if the contract otherwise meets the QLAC annuity requirements) until 2016. Staff also kept the QLAC simple (for example, no variable annuity contracts will qualify), thus keeping it very affordable.
Even though the establishment of the QLAC provides a good planning tool, for sure, and it does provide a modest tax benefit, that is not the real story here. The true impact of the QLAC reg, and what makes it so very important, is that it establishes the foundation under tax law by which DC plans can simply annuitize.
So, before you dive into the close details of the QLAC (and we will do that, as will many others, I’m sure, over the coming months), lets first turn to the tax rules that actually make lifetime income work in a defined contribution plan. You will need to understand what it takes to put an annuity into a plan, as well as what it takes to distribute an annuity from the plan. I invite you to read the preamble to the originally proposed QLAC reg, as well as Rev Rul 2012-03. Between these two pieces of guidance, you find some very basic instructions on how DC annuitzation-even beyond QLACs- will work. Here’s a brief list of key elements:
- Lifetime income product treated as an investment in a DC plan. The preamble to the proposed QLAC and Rev. Rul. 2012-3 together confirm a crucial analysis: An annuity contract can be generally (with important caveats) be treated as a plan investment rather than as a plan benefit. This means a plan can safely purchase a wide variety of annuities (and get rid of inappropriate ones) without having to deal with plan language governing benefit structures and all the attendant inflexibilities.
- Distribution of the annuity. Critical for many plans and record keepers is the ability to distribute the annuity from the plan, so the plan won’t be “stuck” with an outside asset for a lifetime. QLACs, as other annuities, can be distributed from a plan in ways similar to the ways that annuities could be distributed from terminating DB plans. These are “Qualified Plan Distributed Annuities” which, by the way, helps address the problem of “portability ” of these contracts. As long as a plan permits in-kind distributions, it should be able to distribute an annuity.
- Clarification of application of Spousal Rights. Although an annuity purchase may be an investment and not a benefit, Rev. Rul. 2012-3 and the QLAC clarify that spousal rights would still apply on distribution of funds from the annuity- even if the annuity is distributed from the plan. The guidance also describes the manner in which those rights would be enforced.
- Annuity starting date. Of all things, one of the biggest issues that needed to be resolved is when the annuity starting date begins for an annuity contract is purchased by a plan. This is important because the annuity starting date determines when the QJSA rules apply and related notices, and impacts the calculation of the required minimum distributions. Rev Rul 2012-3 ruled that the annuity starting date is the date the the election to annuitize becomes irrevocable under the contract. I’ll explain this in further detail in another blog.
- Annuity Administration. The guidance effectively sets the stage, under standard DOL and state contract rules, for the “nervous administrator” of a plan effectively to delegate to annuity companies the role of administrator. There may be a number of insurance products under which it is yet unclear how the guidance would apply to the terms of specific products, but at least there are “stakes in the ground” from which to make such determinations.
There is more work to be done on tweaking a number of rules, but a clear structure is in place. It does not solve the problem of adequate lifetime income, but it provides policymakers and the marketplace with a critical tool by which to address the issue. It also does not address the fiduciary issues related to the purchase of annuities, but much work is being done to address those concerns as well. Stay tuned!
OK, So, what is a QLAC, anyway?
An annuity contract is a QLAC, and thus its premium being excluded from RMD calculations of a plan, if the following requirements are met:
- the annuity is a simple straight life annuity payable beginning at an age not to exceed age 85;
- the annuity not be a variable annuity (or any annuity contract with an account balance), though the benefit can be adjusted for cost of living increases. Insurance experience dividends can also be paid on them;
- the only death benefits be a continuing lifetime payments if the QLAC were a joint and survivor annuity. There can be no surrender value except for a “return of premium” (“ROP”) provision, which is newly allowed under the final regulation. There are also special rules for determining the payouts to non-spousal beneficiaries;
- only funded DC plans and non-Roth IRAs can purchase them. DB plans, non-governmental 457(b) plans or Roth IRAs cannot purchase them. The IRS has requested comments on whether or not QLACs should be provided under defined benefit plans;
- the amount of premium paid for the contract does not exceed the lesser of $125,000 or 25% of the participant’s or IRA holder’s account balance. This is an increase from the proposed $100,000 amount;
- the special rules for determining how the RMD rules apply to payments from QLACs, including a special rule for 403(b) plans are followed; and
- the insurance companies issuing the QLAC (not the TPA or the plan sponsor) files annual reports on the QLAC to the IRS and copy the participant, similar to that required under the IRA Form 5498. The IRS will need to develop new forms for this reporting.
The final regulations also made important other changes to the proposed regulations:
- The proposed regulations required insurance companies to state that the annuity contract or certificate was a QLAC. In response to insurance industry concerns, the final regulations adopted a transitional rule. Insurance contracts issued before January 1, 2016 will not need to specifically state that they are QLACs, as long as the participant is notified at the time of purchase, in writing, that the contract is intended to be a QLAC, and that a rider that contains the QLAC language is issued by January 1, 2016.
- No special initial disclosure rules will be required upon the purchase of a QLAC, which is a change from the proposed regulation.
- The final regulations provide a one-year widow to correct QLACs which exceed the dollar limitation.
Much, much more to come.