Treasury Promotes Lifetime Income Options for Retirement Plans

by: Dennis Zuehlke, Compliance Manager, Ascensus

The Treasury Department has issued proposed regulations on longevity annuity contracts to encourage their use and make offering annuities and other lifetime income options to retirees easier.

The proposed regulations come on the heels of growing concern that retirees will outlive their retirement assets. Much of the retirement focus during the Bush Administration was on increasing retirement plan contribution limits and pension plan portability to ensure that future retirees would have adequate assets for a secure retirement. But, the continued decline in traditional defined benefit pension plans in favor of defined contribution plans—such as 401(k) plans—coupled with the 2008 economic downturn that decimated the retirement plan balances of Baby Boomers nearing retirement has increased the focus on ensuring that current and future retirees do not outlive their retirement savings.

Unlike traditional defined benefit pension plans that provide for a lifetime stream of income at retirement, defined contribution pension plans generally offer a lump sum option. This places the onus for managing the assets in retirement on the participants and increases the risk that the participants will outlive their benefits. The proposed regulations are designed to remove regulatory barriers and make it easier to use pension plan and IRA assets to purchase annuities that provide for lifetime income streams.

The proposed regulations make it simpler for pension plans to offer a partial annuity option, modify the required minimum distribution (RMD) rules, and provide for a new type of annuity contract referred to as a qualified longevity annuity contract (QLAC), which provides annuity payments to an account owner beginning at an advanced age.

Encouraging Partial Annuity Options
The use of annuities and other lifetime income products has declined along with the decline in traditional defined benefit pension plans. The proposed regulations change a regulatory requirement so that the calculation of a partial annuity will be streamlined, making it easier for pension plans to offer an annuity option, in addition to a lump-sum payment option. This change is intended to encourage more plans to offer—and participants to choose—a partial annuity, which allows for participants to receive a lifetime stream of income, rather than taking their entire distribution as a lump-sum payment, and thereby reducing the risk that the participants will outlive their savings.

Required Minimum Distribution Calculation Changes
RMD calculations are generally based on the prior year-end account balance, or in the case of a defined contribution plan, the last valuation date in the preceding year. The proposed regulations provide an adjustment to this balance if the account owner purchases a QLAC. The account balance is reduced by the value of the QLAC to arrive at the amount to use for the RMD calculation. This, in essence, eliminates the potential need to begin taking distributions from the QLAC earlier than anticipated, which would increase the cost of the annuity and reduce the account balance faster than may be necessary.

Qualified Longevity Annuity Contract
A QLAC is an annuity contract that meets certain requirements and is purchased from an insurance company, using assets in a qualified defined contribution plan, tax sheltered 403(b) plan, eligible governmental 457(b) plan, or IRAs (other than Roth IRAs). To qualify, the maximum amount of the premiums paid to a QLAC under a plan is the lesser of $100,000, or 25 percent of a participant’s account balance. Distributions from the QLAC must begin no later than age 85, although they may start earlier based on the terms of the annuity contract.

This regulatory change is designed to encourage participants to use a limited portion of their retirement savings to purchase a QLAC, which would provide guaranteed income for life starting at an advanced age, usually 80 or 85. This would ensure that participants would not outlive their retirement savings, since payments from the QLAC would begin at an advanced age and continue for the remainder of the participant’s life. Participants would then be better able to manage the remaining portion of their retirement savings knowing that payments from the QLAC would begin once they reach an advanced age.

Impact on IRA programs
These proposed regulations have the potential to impact credit union IRA programs. Rollovers and transfers from pension plan and IRA distributions represent 80 percent of all new IRA contributions at credit unions, and any decrease in the dollar amount of lump-sum payouts would decrease the amount of money available to be rolled over to credit union IRA programs. IRAs are a key source of long-term stable deposits for credit unions. While credit unions may not be looking for additional deposits in the current economic environment, the need for additional low-cost funding sources—such as IRA deposits—will be critical once lending rebounds.

The IRS has asked that comments on the proposed regulations be submitted by May 3, 2012, with a public hearing to be held on June 1, 2012. It remains to be seen if the proposed regulations will increase the use and offering of annuities and other lifetime income options to retirees and what impact, if any, assets flowing into QLACs will have on credit union IRA programs. But with 10,000 Baby Boomers reaching age 65 every day, ensuring retirees don’t outlive their retirement savings is likely to be a top Obama Administration priority. Stay tuned.

Dennis Zuehlke is Compliance Manager for Ascensus in Middleton, Wisconsin. Mr. Zuehlke provides clients with technical support on tax-advantaged accounts (including individual retirement accounts, health savings accounts, simplified employee pension plans, and Coverdell education savings accounts), and information reporting and tax withholding issues. Mr. Zuehlke is a frequent national speaker on compliance-related issues and retirement savings trends within the financial services industry.

Mr. Zuehlke attended Marquette University and graduated from the University of Wisconsin. Prior to joining Ascensus, he held a similar position with the Credit Union National Association.

Ascensus delivers a full range of retirement plan services—including plan administration, plan design and maintenance, consulting, web-based tools and content, software solutions, education and training, forms and documents, and technical resources—to approximately 9,000 financial organizations nationwide. www.ascensus.com