New regulatory guidance eases the path to deferred annuities in TDFs


The IRS and the DOL last month issued guidance that removes some of the barriers to the use of deferred annuities as the fixed income part of a Target Date Fund (TDF). Mike Barry of Plan Advisory Services describes this as adding: “what many would consider to be a ‘best practices’ retirement income solution—a life annuity distribution—to what many consider to be … the ‘best practices’ investment solution—a target date fund.”

The IRS guidance addresses the concern that this approach may breach Tax Code nondiscrimination rules. The DOL guidance was in response to the questions: (1) would the inclusion of deferred annuities cause the TDF to fail to qualify as a Qualified Default Investment Alternative (QDIA)? and (2) would the DOL’s annuity selection safe harbor apply in this case? On all three questions, the recent guidance is favorable. (More details are available in Mike’s note on the subject.)

Russell’s initial response—in a Jeff Eng post on our corporate blog a couple of weeks ago—was that this is “a clear signal that our regulators are joining the drive for proper retirement income planning based on tangible outcomes.”

Here’s why the regulators are interested: longevity pooling—which is one of the defining features of annuities—makes providing retirement income easier because it means you only need to worry about the aggregate mortality of a large group of people, and that is much more predictable than the mortality experience of one individual. But when DC took over from DB as the new retirement superpower, longevity pooling got lost in the process. So there was a step back from the goal of providing not just a savings vehicle, but a retirement income vehicle. That’s what is driving the interest in this area.

The way I see it, a deferred annuity is basically a combination of a fixed income investment and longevity pooling. So if regulators want longevity pooling built into the DC system – a system whose core is now the target date fund—it’s easy to see why they’d like the idea of using deferred annuities as the fixed income component of TDFs.

It is hard to say whether or not the removal of these barriers will cause a surge in new products. It certainly seems likely to spark some new thinking. But some practical considerations remain, including: liquidity, portability, fee transparency, record keeping, and participant communication. Further, the safe harbor mentioned in the DOL guidance is subject to several conditions, including a thorough search process and an appropriate conclusion that the annuity provider will be able to meet its commitments. And the Treasury and the IRS have not yet decided whether to provide guidance on the use of guaranteed lifetime withdrawal benefit (GLWB) or guaranteed minimum withdrawal benefit (GMWB) features, and the product landscape may change again if that happens.

In any case, let’s face it: annuities have never really been as popular among pension plan participants as the academics and other commentators think they should have been. Nonetheless, as the regulators continue to explore ways to encourage greater focus on retirement income, product providers and plan sponsors would be wise to pay attention.


Leave a Reply

Your email address will not be published. Required fields are marked *