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A Safe Harbor for Annuities Could Help Retirement Savers

Policy changes pending in Congress may make lifetime income more accessible

Aron Szapiro

 

A last-minute change to a bill that recently passed the U.S. House could improve how Americans save for, and spend in, retirement.

But you’d never know that by its name.

The amendment is called the “Fiduciary Safe Harbor for Selection of Lifetime Income Provider.” The idea has garnered rare bipartisan support in the Senate. It was added to H.R. 6757, known as the “Family Savings Act of 2018,” before the bill cleared the House last month.

The Act has several tax provisions that aren’t likely to find enough Senate support, but other provisions—including letting small employers band together to offer retirement plans—have now found support in the House and Senate. So, we might just see a policy change that makes it easier for Americans to access lifetime income options by making it easier for 401(k) plans to offer annuities.

How a safe harbor for annuities could help retirement savers—and retirees

Theoretically, at least, many retirees should annuitize at least a portion of their retirement savings. Annuities protect retirees from investment risk and longevity risk, or the possibility that they might outlive their savings.

Of course, in practice, retirees may not want to give up so much liquidity. They may wish to leave their heirs a bequest, and Social Security provides an inflation adjusted annuity that can offer quite high levels of income replacement to many working-class retirees, while many others still have some income from traditional defined benefit plans.

Nonetheless, annuities are a potentially useful way to convert savings into lifetime income. In fact, Morningstar Investment Management LLC’s David Blanchett has demonstrated in his research that introducing annuities as part of defined-contribution plan default options could help more workers prepare to transition from retirement savers to retirement spenders. The U.S. also lags other countries in promoting annuities, as I’ve argued in the past.

What policymakers could do to change regulations

So, if annuities are valuable, why do so few 401(k) plans offer them as an option?

In 2016, the U.S. Government Accountability Office found that just a handful of plans offered annuities because of concerns about fiduciary liability. In short, the employers that offer retirement plans told the government auditors that current regulations require them to ensure an insurer will be financially secure enough to pay for future benefits but gives them no guidance on how to reasonably reach that conclusion. Since workers aren’t demanding annuities, employers figure it’s not worth the risk that an insurance company might have financial trouble in the future and so they don’t offer them.

What could policymakers do? They could reform regulations for a safe harbor for plans sponsors offering annuities by adding detailed criteria. That way, plan sponsors can assess an annuity provider’s long-term health with some assurance that they will have met their fiduciary obligations. In fact, the Government Accountability Office recommended that the Department of Labor write such regulations back in 2016. But as of now, the agency has only said it plans to tackle this eventually in its regulatory agenda and hasn’t offered a specific timeline.

Options and the prognosis for change

This lack of action from the Department of Labor brings us back to the Family Savings Act.

The Act, combined with legislation pending in the Senate that has similar provisions for a safe harbor for selecting annuity providers, there seems to be a real possibility that Congress will set such detailed criteria. The bills have very specific criteria for plan sponsors to review to ensure that annuity providers are fiscally sound. However, we‘re running out of time this legislative session.

Still, this is an idea that policymakers across both aisles, both houses of Congress, and in the executive branch want to implement. The only question is whether they want to do it badly enough to get it done.

Please see below for important disclosure. 

Read more about what U.S. policymakers can do to improve the retirement system in our paper “Small Employers, Big Responsibilities.”

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Important Disclosure

Morningstar Investment Management LLC is a registered investment adviser and subsidiary of Morningstar, Inc. The Morningstar name and logo are registered marks of Morningstar, Inc. Opinions expressed are as of the date indicated; such opinions are subject to change without notice. Morningstar Investment Management and its affiliates shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, the information, data, analyses or opinions or their use. This commentary is for informational purposes only. The information data, analyses, and opinions presented herein do not constitute investment advice, are provided solely for informational purposes and therefore are not an offer to buy or sell a security. Before making any investment decision, please consider consulting a financial or tax professional regarding your unique situation.

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