Qualifying lifetime annuity contracts in July 2014 became another option for defined contribution plan sponsors to offer to assist with retirement income security when the U.S. Treasury Department and IRS issued final regulations allowing them. Now, plan sponsors and participants near retirement age face some confusing choices when considering whether QLACs are right for their plans or retirement savings strategy.
Under these regulations, IRS is allowing participants to use part of their account balance to purchase a QLAC without being socked with tax penalties for not withdrawing funds early enough. Generally, QLACs withdrawals don’t begin until age 85 or older; however, retirement plan rules require withdrawals to begin at age 70 ½ — and any delay results in a penalty. (See July 2014 story.)
Concerned that this conflict discouraged plan participants from using QLACs, IRS has established rules designed to “provide for greater security by giving American families more flexibility to plan for retirement and protect themselves from outliving their savings,” according to the agency.
The Feb. 10 installment of the regularly occurring Thompson Information Services #hrintelchat on Twitter featured ERISA attorneys and QLAC experts Tom Clark of the Lowenbaum Partnership and Chris Rylands of Bryan Cave law firm sharing insights and advice on how plan sponsors can best incorporate and administer this new plan feature for older workers.
The following is an edited version of their conversation on Twitter.
Q: What is a QLAC, as defined by IRS final regulations made effective last July?
Clark A: Qualifying lifetime annuity contracts that provide an income stream to address longevity risk or outliving your money.
Q: Why would a defined contribution plan sponsor consider adding this feature?
Clark A: Provides a safety net that employee otherwise may not get elsewhere. Better-designed plans attract better employees.
Rylands A: It’s a small way of “pension-izing” DC plans (I think I just made that word up).
Q: Who is a QLAC for?
Clark A: Anyone who primarily relies on qualified plan assets to fund retirement, i.e. 401(k) or IRA. Anyone who has money saved up in another place may not need this option.
Rylands A: That’s a good point. People should always consider all their assets when planning for retirement. And to be clear, this isn’t necessarily lifetime income. It’s income that starts at an older age and then continues for life.
Q: How can a plan sponsor modify a DC plan to provide lifetime income with QLACs?
Rylands A: First, the plan sponsor will need to amend the plan to allow these annuity distributions. It probably also will need to amend the 401(a)(9)/ required minimum distribution language to address QLACs.
Clark A: Plan sponsor should work with provider, adviser and/or benefits counsel to modify their plans to include QLACs.
Q: What plan design options do plan sponsors have?
Clark A: Return-of-premium death benefits may be included. Life annuity payments available to spouse and non-spouse beneficiaries. If the recipient dies before the QLAC starts, then all they may get is a return of premiums.
Rylands A: Although I suspect most insurers will be flexible on the features (within the confines of the rules).
Clark A: That’s right. The limits are generally the lesser of $125,000 or 25 percent of the account balance. The sponsor can also further restrict the amount of money that can be put toward the premium than is limited by IRS.
Rylands A: This is an important point. These regs are new. Providers will continue to innovate products as time goes on. The features may depend on which insurer(s) the plan sponsor picks to offer the QLAC. The $125,000 limit applies to all accounts combined (plans & IRAs). The 25-percent limit is per plan, but aggregated for IRAs.
Q: Are these regulations in effect now?
Rylands A: Yes. They became effective July 2, 2014, to annuities purchased on or after that date.
Q: You touched on this, but how are RMD rules for retirees affected by a QLAC purchase?
Rylands A: A QLAC is excluded from the account balance for purposes of the RMD calculation. This means smaller RMDs.
Clark A: If QLAC requirements are met, the annuity payments are subject to RMD rules on a limited basis, as explained by the regs. Getting around RMD rules is effectively the entire reason for these regs.
Rylands A: Exactly. That and insuring against longevity risk. The IRS did some creative backflips to get around RMD rules. The QLAC rules are part of an overall government push to “pension-ize” DC plans.
Q: Are these regulations a safe harbor for plan sponsors that offer annuity products in their plans?
Clark A: This is not a safe harbor. It’s a mechanism to get around RMD rules; to not push all DC money out of an account.
Rylands A: However, if a contract would not be a QLAC because of excess premiums, it can qualify if the excess is returned to the account. The bottom line is that it’s not a safe harbor, but there is some limited ability to correct if the contract is not a QLAC.
Q: What type of litigation exposure does a plan sponsor or fiduciary face when offering QLACs?
Rylands A: Sponsors need to be careful in selecting annuity providers and follow the [U.S. Department of Labor] safe harbor. If the annuity provider goes belly-up, the DOL or participants may sue.
Clark A: Litigation exposure is similar for the selection of any other provider and investment. Make sure to have a process and document it. Get help from an expert if you need it.
Rylands A: That’s a good point, too. It’s important, as always, to check the fees.
Clark A: Agreed. This is probably the biggest risk. No new guidance has been issued. Worth looking at guidance regarding other annuities.
Q: Now a step back to look at the bigger picture. Once a new QLAC option is chosen, how should an employer retirement plan publicize and explain it to plan participants?
Rylands A: I think the most important part is to explain that it helps avoid outliving one’s money. Then, if you have a return-of-premiums feature, I’d be sure to explain that, too. Participants are concerned about longevity risk, but also don’t want to “throw money away,” so those two points are important. This is insurance, and describing it like that may help employees understand it.
Clark A: Provide a good written explanation. Offer an in-person meeting if it makes sense. One-on-one explanations would be best.