The Treasury has announced proposed regulations and rulings regarding lifetime income choices. This guidance presumes that employers want to adopt more pension risk by providing more annuity options in their defined contribution and defined benefit retirement plans.  (For links related to this new guidance, see bottom of this post.)

In its fact sheet, the Treasury discusses the financial risks of retirees and explains that the Treasury and Labor Department have undertaken an initiative to provide “more options for putting the ‘pension’ back in our private pension system.” Through this guidance, the Treasury is “removing regulatory barriers” to allow employers and IRAs more opportunity to pay monthly income payments for life. This includes:

  1. Clarifying how defined contribution plans can offer the option of a deferred annuity under the plan consistent with the plan qualification rules.
  2. Making it easier for defined contribution plans and IRAs to offer the option of longevity annuities.
  3. Clarifying how a defined benefit plan can offer defined contribution plan participants the option of purchasing an annuity from the defined benefit plan.
  4. Making it easier for defined benefit plans to offer the option of partial annuities.

With regard to employer-sponsored plans, each of these options involves shifting pension risk from the individual, onto the employer through an employer-sponsored plan. This guidance is based upon the presumption that employers want to assume more pension risk: either the fiduciary risk associated with selecting an insurance company annuity, or the financial risk associated with offering an annuity form of payment in a retirement plan.

Back in 2008, Vanguard explained why employers typically do not provide “in-plan” annuity options in defined contribution plans (options 1 and 2 here). Annuities involve substantially more risk to the employer, and substantially more administration. ERISA and the Department of Labor regulations set high due diligence standards for employers selecting annuity providers and annuity products, and the analysis can be complicated. Further, an employer never really has comfort that it is “done,” as an insurance company failure many years down the road could come back to haunt the employer. The Internal Revenue Code also imposes additional qualified joint and survivor annuity requirements, and notice and consent requirements. The new guidance ignores these factors, and adds on more administrative complexities. Accordingly, we do not anticipate much employer take-up on the offer of more pension risk.

Options 3 and 4 ignore the many reasons behind the decline in defined benefit plans and an increase in lump sum distributions, such as the threat of increases in PBGC fees. Last fall, the PBGC, which had a 2011 deficit of $26 billion, asked Congress for a significant increase in premiums and authority to set future premiums. Now, American Airlines is heading toward the largest default of a pension plan in United States history. If the PBGC were to assume the American Airlines plans, its deficit would increase by over $8 billion. In other words, this pension risk / liability would be shifted to the remaining defined benefit plan sponsors, or to taxpayers. It would be surprising to see the employers who are racing to cash out participants before premium increases hit change course and embrace options 3 and 4. For that matter, we doubt that employees who are learning about PBGC limits on benefits will be clamoring for these options any time soon.

This lifetime income options guidance was presented as a “meaningful first step.” Economic security in retirement is a complicated risk management issue, and moving the needle on this important issue is going to require a lot more than presuming that employers who are bracing for 2014 health care reform costs will assume additional pension risk.

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