Retirement plans have received a lot of attention from lawmakers in recent years. In 2019, the Secure Act resulted in some dramatic changes to retirement plans. One of the major changes was the possibility to incorporate annuities, which provide lifetime income, into both 401(k) and 403(b) plans.
These products make it possible for employees to create retirement plans that more closely resemble traditional pension plans. Now, a newly proposed piece of legislation called the Lifetime Income for Employees (LIFE) Act would expand this access even further if it passes.
The Key Points to Know about the LIFE Act
The LIFE Act was introduced into the House of Representatives by a Democrat from New Jersey and a Republican from Michigan in February 2022. If it passes, the LIFE Act would rewrite the United States Department of Labor (DOL) rules to allow plans to offer annuities to participants as a default investment.
This means that annuities would become a Qualified Default Investment Alternative (QDIA), which collectively account for a very large portion of retirement plan assets. Vanguard, a financial services provider, says that 62 percent of its defined contribution plans were invested solely in an automatic investment program. This frequently means a single asset allocation or target-date fund.
The Security Act refrained from allowing annuities to become default options because the DOL has set liquidity requirements. According to the current rules, a QDIA must have enough liquidity to let plan participants withdraw assets or transfer them to another investor at least once every 90 days. Because annuities typically need long-term investment lockups, they get excluded from the QDIA category.
Annuity products often have liquidity restrictions built into them to help the entities offering them back the guarantees they make. This holds especially true guaranteed fixed annuity products, which are the primary choice for people who want to secure guaranteed income over the course of their retirements. The LIFE Act addresses this issue.
If the LIFE Act becomes law, plan sponsors would be allowed to place up to half of a participant’s assets into an annuity QDIA. Then, participants would have 180 days to move their money out of the annuity and free themselves from the liquidity restrictions. This includes a notification prior to 30 days of the end of the liquidity restrictions that helps participants understand what it means not to have this liquidity.
The legislation seeks to make annuities more accessible while protecting investors from making illiquid investments if that is not what they intend. Increasing access to guaranteed income in retirement can help people plan more accurate budgets for their retirement years, which could prevent them from running out of money.
The Likelihood of the LIFE Act Becoming Law
Experts believe that the LIFE Act will likely become law because of the bipartisan support that it is receiving. The financial industry is also largely supportive of this proposed legislation. After all, annuities could mean that financial advisors have fewer assets to manage since employee assets would be significantly less liquid.
However, the demand for financial advice would remain high. Employees will need guidance on how much of their retirement funding they should allocate to an annuity, especially considering the liquidity concerns involved. One of the effects of this act could be that employees become more proactive about their financial planning and put more energy into thinking about how they should save for retirement to achieve their personal financial goals.
Concerns About the Lack of Specificity in the LIFE Act
While the LIFE Act is exciting for employees saving for retirement through sponsored plans, there are some details that need to be ironed out before the legislation passes. For example, there is currently no stipulation about the types of guaranteed annuities that can be used as QDIAs. Annuities plans can vary a great deal in terms of structure and terms.
For example, some annuities have a qualified longevity annuity contract (QLAC) that begins paying out when participants turn 80. However, other annuities may begin paying participants as soon as they retire, although at a lower rate than those that require waiting until 80. These different structures also have different tax implications, it will be important to define the types of annuities that can become QDIAs.
Currently, QLAC annuities do not get taxed. Because of this, the IRS created a rule that no more than 25 percent of a plan participant’s portfolio can be invested in one. Otherwise, QLAC annuities could become strong tax shelters. The LIFE Act does not clarify whether the limit for QLAC annuities would be increased to 50 percent.
Furthermore, the legislation does not clarify the protections or liquidity options available to plan participants who need to liquidate because of a monetary emergency. Some annuity products do provide these liquidity options, so it is possible to make them available to plan participants.
With the current wording of the legislation, plan sponsors would have a lot of discretion in choosing the annuities that they include, which could cause inequities in the long run. Furthermore, there is some concern that the guaranteed payouts will be low compared to the returns from investing that same amount of money.