Not a lot of attention is being given in the” benefits press” to Section 109 of the SECURE Act, which enables something called “Portability of Lifetime Income Options.” But it is one of those fundamental building blocks with which -regrettably or not, depending on your view of things- all benefit professionals and all plan sponsors will have to eventually deal. Given that it is effective now, there is some urgency in understanding this thing. One of the challenges is that annuities within Defined Contribution plans are not generally well understood, so I invite you to explore the blogs which show up in “Lifetime Income” under the “Topics” drop down menu in the sidebar of this webpage. This may prove to be a valuable resource to you.
Background of the “Portability Issue”
First, some background. For all the attention lifetime income has been getting in the marketplace over the past few years, annuities have had surprisingly little take up with employers. Some claim it’s because of the fiduciary concerns, which is why we have SECURE Section 204 (which has a fiduciary safe harbor for the purchase of annuities), but I doubt that was as big as a problem as others would make it out to be. I think its really much simpler: people neither like or understand insurance products, and don’t trust insurance companies. Industry experts themselves have boiled this down to “Four I’s”- Irrevocability, Inflexibility, Inaccessibility and Invisibility-to which I added a fifth- Immobility.” Check out two dated but still effective blogs which describe this in more detail at Part 1 and Part 2. No, I did not complete the blog on “Immobility, ” but that is what Section 109 is all about.
You see, lifetime income guarantees can really only currently be provided by state-licensed insurance companies issuing annuity contracts and by governmental programs(though there are efforts underway to change that, thus the quirky language in the Act is designed to accommodate these innovative product efforts). Annuity guarantees, however, are not generic (each insurance company’s terms and pricing are each a bit different), nor are they terribly liquid. When there is a plan transition, lets say a merger; or where the insurance product falls out of fiduciary grace with the sponsor; or when a participant leaves the plan sponsor and wants to continue to add to the annuity in their own IRA; there are really limited options. Too often, the only solution would be to liquidate the annuity and then repurchase another. The problem is that annuities are designed (and priced) to be held for a lifetime, and early termination often results in a loss of value through a variety of termination charges (these charges, by the way, enable more favorable pricing on the active annuity).
Section 109 actually fixes this problem. For the participant who does not have a distributable event, but the plan ceases its relationship with the insurer for whatever reason, Section 109 permits that participant to maintain that annuity by taking an “in-kind” distribution of it. The participant can hold it (and it still has the attributes of a 403(b), 401(k) or 457(b) plan, as the case may be), or by converting it into an IRA (the term “qualified plan distributed annuity” has been the term used in the past. It looks like SECURE is now calling them a “‘qualified plan distribution annuity contract” or QPDAC, I suppose). For the participant who leaves the employer, contributions might still be made to it if the participant is eligible for IRA contributions by converting the QPDAC to an IRA, or it can be be rolled over into another qualified plan (should the plan permit it).
You can see how this rule is going to have widespread impact. These are incredibly substantial changes, for which there is yet little guidance-and little familiarity with in the market.
The Plan Document Problem
There’s a lot to be done to get up to speed on the QPDAC. The first, and most fundamental, issue is that these things only work when they are treated as an in-kind distribution of a plan investment, as opposed to a benefit provided under the plan. This means, for example, plan document language which only permits a “lump sum cash distribution” won’t work; but language which permits either a simple “lump sum distribution” or a more specific “in-kind distribution of an annuity contract” will work. It would be a serious mistake to build annuity payment options into the plan’s benefit terms as, for a variety of reasons, it will seriously screw up the DC plan.
The second immediate drafting issue is the application of the joint and survivor annuity rules. If you draft it wrong, you will end up having those difficult rules apply to all the distributions under under the plan. Take a look at my blog here which should help you out there.
There will now much detail to work through.