Americans may soon see some welcome changes to the rules governing their retirement savings plans, including the ability to contribute to their individual retirement accounts longer or tap them to help pay for the arrival of a new child.
But the same bipartisan bill could also make retirement planning even more confusing, particularly for workers hoping to recreate the pensions of a bygone era.
Among the two dozen or so rule changes is a provision that is strongly supported by insurance companies but has consumer advocates worried. It would eliminate some of the liability for employers who add annuities to the menu of options for their 401(k) plans — including expensive and complex products that purport to offer the peace of mind of a guaranteed income stream.
“There will come a time where we will point back to this as the start of a trend toward high-cost annuities being offered in 401(k) plans to the detriment of retirement savers,” said Barbara Roper, director of investor protection at the Consumer Federation of America.
The proposed changes are part of H.R. 1994, the Setting Every Community Up for Retirement Enhancement Act of 2019, which passed the House with an overwhelming bipartisan majority on May 23. The bill would also allow small businesses to band together to create retirement plans and broaden the uses of college savings accounts. Leaders in the Senate are now pushing to take up similar legislation, which also has wide support and was first introduced in 2016.
Annuities can be part of a well-founded retirement strategy. Typically, workers invest in low-cost stock and bond funds to build a nest egg, then use some of that money to buy a simple annuity, which provides regular checks for the rest of their lives. Experts say some variation of this strategy is usually the most efficient approach to recreating a paycheck in retirement.
More complex annuities, like so-called indexed annuities and variable annuities, are less common in corporate 401(k) plans but could become more mainstream if the bills become law. These products are more lucrative for insurers because they tend to have higher costs in return for the extra features they add.
Equity-indexed annuities, for example, guarantee you won’t lose money — and if a certain index, like the S&P 500, rises, the insurer will credit a portion of any return to your account. Variable annuities allow you to choose how to invest your savings and are often sold with so-called guaranteed lifetime withdrawal benefits, meaning you can receive regular checks and still have the option to take back some of your money.
But these features come with extra costs, which are often hard to decipher.
“The insurance companies won’t sell budget, simple immediate annuities — the kind most of us want,” said Teresa Ghilarducci, a professor of economics at the New School for Social Research and an expert in retirement policy. “They will sell variable annuities that are typically complicated and overwhelmingly expensive to be appropriate for most families.”
There is often little benefit to saving your money inside products like variable annuities over many decades because of the high costs, experts say, which leaves you with less money once you reach retirement.
Some employers, including United Technologies, have already experimented with complex annuities. After it closed its pension plan for new workers, the company created an option that invests a portion of workers’ savings in a variable annuity. And executives from the investment giant BlackRock said they were working on other ways to include guaranteed income streams in retirement plans.
“These next generation products need to be simpler, cheaper and more transparent,” said Dan Basile, head of product management for BlackRock’s defined contribution business. “That is where we are focusing our innovation efforts.”
The legislation is intended to make employers — who must act as fiduciaries, and choose the best retirement plan options for workers — more comfortable embracing annuities. And as more states and employers struggle under the weight of their pension obligations and look for alternatives, they may increasingly look to annuities.
Employers have long been reluctant to include annuities among their retirement offerings because they feared being sued if an insurer could not make the guaranteed payments — something that could happen decades after affected employees left the company.
The legislation would assuage those concerns by adding a provision that protects employers from liability in such cases. If the insurer went insolvent, retirees would be able to seek redress from state insurance guaranty associations, which provide a backstop to their benefits up to certain limits.
Some experts worry that companies — particularly smaller employers — will be more likely to choose problematic products, in large part because they often rely on brokers to educate them about complex annuities. And these brokers are typically not required to put the customer’s interest first.
“It’s possible that the safe harbor will be marketed in a way that makes plan sponsors, and particularly small plan sponsors, believe that they don’t need to review the annuities at all,” said Fred Reish, a lawyer with Drinker, Biddle & Reath and an expert on 401(k) fiduciary issues. “That would be a mistake.”
There is also concern among experts that the insurers who would be provided with an attractive new market for annuities will not necessarily be up to the task.
The legislation does not require employers to limit their annuity offerings to those from insurance companies with the best financial ratings, which are an indicator of financial health, just those who have been operating for at least seven years that meet regulators’ requirements.
“Adding such ratings as a condition would make this very good bill better,” said Mark Iwry, who was responsible for national retirement policy and regulation while serving as a senior adviser to the secretary of the Treasury during the Obama administration.
Some experts envision a scenario where companies that have never before sold lifetime income annuities will enter the market but price them inappropriately. That could risk leaving workers and retirees with little to show for their money.
“In the interest of getting into the market, some insurers who are not viable for the long term could price their annuities in a way to try to enter the space,” said Jerome Schlichter, a lawyer known as a pioneer in suing employers over retirement plans workers thought were mismanaged and too expensive.
He added that possibility made it all the more important that employers and retirement plan managers should keep a close eye on the insurance products they picked if they did not want to risk a collapse that left their retirees with an insolvent annuity, which might require the government to step in.
“It will be up to the fiduciaries to not only to monitor fees and the annuity itself,” he said, “but also to monitor the solvency of the insurer.”
How the House Bill Would Help Retirees and Savers
The retirement legislation that the House recently passed with an overwhelming bipartisan majority includes a series of provisions that would affect different groups of American savers and retirees. One change would open the door for complex annuity products to become part of your employer’s retirement offerings, but that’s just one provision.
Here’s a sampling of some other changes the bill would make:
— Allow workers to contribute to an individual retirement account indefinitely, rather than up to the age of 70 1/2.
— Raise the age at which individuals are required to begin taking withdrawals from their IRAs to 72, from 70 1/2.
— Allow penalty-free withdrawals from retirement plans to pay for the costs related to the birth or adoption of a child.
— Enable more part-time workers to participate in 401(k) plans.
— Permit savers who have leftover money in their 529 college savings plans to use up to $10,000 of that cash to pay back student loans, including for their siblings.
— Permit small businesses to band together to create retirement plans for their workers, which the bill’s supporters say would give access to investments and administrative services at a lower cost.
— Require some people who inherit retirement accounts like 401(k)s and IRAs to empty them — and pay taxes — within 10 years, instead of being able to stretch withdrawals over their lifetime. Some beneficiaries are exempt, including spouses. This provision would help pay for the bill’s various changes.