An important and separate “tool,” if you will, in the professional’s portfolio for use in assessing and understanding the manner in which any lifetime income program will fit into any particular DC plan is simply recognizing that annuities (1) are a necessary element of providing lifetime guarantees under DC plans; (2) are normal; (3) have been used in DC plans for, literally, generations; and (4) that their use is supported by a substantial legal and regulatory infrastructure.
These conclusions resulted from Evan Giller1 and I sitting down for beer and Detroit style pizza in a DC bar (something about beer and annuities, it seems) during the most recent annual TE/GE Council Annual meeting. We were trying to work out how we were going to approach our next day presentation on lifetime income, with Dominic DeMatties and Mark Iwry. Both Evan and I are long time insurance lawyers, each of us having managed law staffs at major insurers which specialize in annuities in DC plans. It finally struck us during dinner that night that our conversations with attendees to the meeting that day starkly showed that few practitioners are familiar or comfortable with the notion on which both Evan and I have spent careers: the normality of annuities in DC plans.
Think about it. Though 403(b) did not show up as an actual Code section until 1958, TIAA started issuing those teacher annuities (what are now 403(b) plans) as early as 1918, and other insurers eventually followed suit; the 1939 Code recognized the non-inclusion in income of those teacher annuity premiums; and the 1954 Code actually first formally provided favorable tax treatment to “Qualified Annuity Plans” under 403(a), which are based upon 401(a) of the Code.2 An interesting historical point is that insurance companies at one time regularly issued 403(a) annuity contracts which had IRS determination letters and whose terms looked a lot like pre-TRA 86 401(a) profit sharing plan documents.
Our presentation ended up focusing on the “normality” of DC annuities, a point with which few in the room were familiar. Our point was that professionals who are armed with the knowledge that annuities are not such strange creatures whose inclusion in DC lifetime income programs are not anomalies of some sort provides them a “leg up” in working through the lifetime income program details for their clients. They’ll find that, historically, there has been little legal risk attendant to plans purchasing, maintaining and distributing annuities in DC plans, and that fiduciary standards have long been met using these heavily regulated and monitored financial products. I‘ll credit Evan with the observation that, indeed, in utilizing one of those annuity rules lurking in the dark corners of the regulatory framework, distributing annuities from plans actually serves to minimize a plan sponsor’s risks in providing lifetime income from a DC plan.
There have been a number of key pieces of guidance issued by both the IRS and DOL over the past decade or so which have served to “bridge” those long standing, dark corners rules, modernizing them to enable the use of specialized annuity designs in retirement plans. A great example of this is Rev Ruling 2012-03, which provided key tax guidance supporting the simplified distribution of QLACs from DC plans. Though that Revenue Ruling further clarified the manner in which the long standing treatment of spousal consent rules apply to QLACs distributed from plans, it effectively brought back to light the also-long-standing manner under which such products can be treated as in-kind distributions of plan investments instead of the payment of an annuity form of benefit under the stated terms of a plan.
It is not an unreasonable observation that professionals have longed looked at annuity contracts in DC plans with, shall we say, “concern,” particularly given some of the opaqueness of important terms upon which parts of the industry have sometimes practiced in the past-to their own detriment. Of course, fiduciaries continue to need to conduct appropriate due diligence. However, annuity products designed for this new generation of lifetime income programs are well worth a closer look, and their use actually has a substantial regulatory infrastructure supporting it.
- Of Counsel to Boutwell and Fay, and co-author of the 2013 paper by the NYU Review of Employee Benefits and Executive Compensation “Regulatory and Fiduciary Framework for Providing Lifetime Income from Defined Contribution Plans.”
↩︎ - It has been long forgotten, btw, that a 403(a) plan offers 401(a)-like- plans, without the top-heavy rules.
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