The SECURE Act
The SECURE Act (Setting Every Community Up for Retirement Enhancement Act) signed on December 20, 2019 establishes several retirement plan changes:
The SECURE Act allows employers to raise the cap on the annual automatic deferral rate, increasing from 10% to 15% for employees who are auto enrolled in their plans.
Required Minimum Distributions (RMDs)
The SECURE Act delays the required minimum distribution (RMD) from 70 ½ to age 72. Individuals that are working beyond age 72 are permitted to delay taking required minimum distributions from most employer-sponsored retirement plans until after they retire. The SECURE Act also repeals the maximum age for traditional IRA contributions which was previously 70½ years old.
Guaranteed Retirement Income
The SECURE Act clears the path for plans to offer guaranteed retirement income to participants. The SECURE Act amends ERISA to create a fiduciary “safe harbor” for the selection of a provider of a guaranteed retirement income product. A safe harbor for fiduciaries regarding retirement income guarantees for participants may cause more plans to offer guaranteed retirement income products in their 401(k) plans.
The Act includes provisions on retirement income, including the safe harbor for selecting a guaranteed income provider, and a new requirement to give participants projections of their retirement income. Plan sponsors can also distribute existing guaranteed income investments in the plan if the plan sponsor no longer wants to offer those products.
Most plan sponsors have been hesitant to offer an annuity as a lifetime income investment option as part of the defined contribution plan design. The SECURE Act offers a safe harbor from liability should an annuity provider fail or stop making payments. The new law also allows lifetime income investments to be transferred among retirement plans when the option is no longer authorized by the original plan.
The providers will most likely be insurance companies but may include new entrants to the market such as banks and financial institutions.
The SECURE Act sets some key due diligence requirements for plan fiduciaries to qualify for the safe harbor as follows:
1) Vendor Search
The plan sponsor should conduct a vendor search for a guaranteed retirement income product provider. The search should include an evaluation of several providers’ products, features, structures and pricing.
2) Financial Capability
The plan sponsor should consider the “financial capability” of the provider to satisfy its obligations under the guaranteed retirement income contract. The new rule provides a safe harbor checklist that includes written representations from the provider or insurance company. The fiduciaries need to be sure that the representations by the insurance company match the requirements in the SECURE Act to create a fiduciary safe harbor for selecting the insurance company. The requirements include the following:
The insurer is properly licensed to offer guaranteed retirement income contracts
The insurer must undergo a financial examination by its State Insurance Commissioner at least every five years
The insurer currently and for the previous 7 years must have:
operated under a valid certificate of authority from its State Insurance Commissioner
filed compliant audited financial statements
maintained adequate statutory reserves for all states where the insurer does business
not be operating under an order of supervision, rehabilitation, or liquidation
After receiving the most recent representations, and there are found to be no other issues concerning those representations, the plan fiduciaries will have completed their review of the “financial capability”.
Although the SECURE Act provides a safe harbor, plan fiduciaries will want to understand and confirm that the selected insurance company is financially strong. Plan fiduciaries may want to vet the insurance companies that they are considering in a more thorough process.
Consideration of Fees and Costs
Plan fiduciaries should consider the all-in costs of the guaranteed retirement contract in relation to the product features, benefits and administrative services under the contract. Fiduciaries must evaluate the “reasonableness” of the total costs, although the fiduciaries are not required to choose the lowest cost product.
Fiduciaries should collect and evaluate pricing information about the retirement income products and make a reasonableness determination before any contract is included on the plan’s recordkeeping platform for participants to select. It would be prudent for fiduciaries to consider
and document the benefits and features of the contract, the appropriateness for the participants and compare them to competitive products for robustness and pricing.
Guaranteed Minimum Withdrawal Benefit (GMWB)
There are currently multiple approaches that employers have utilized in order to offer Guaranteed Minimum Withdrawal Benefits (GMWB). Currently, the most common arrangement found on a recordkeeping platform is a GMWB that is part of the plan’s target date funds. The GMWBs typically guarantee a 5% withdrawal rate beginning at age 65, based on a participant’s highest account value on a contract’s valuation date (highwater mark). If the participant outlives his/her account value or if the market returns do not support a 5% withdrawal rate for the full retirement period, the insurance company “guarantees” to continue making payments after the account is empty. The cost of the guarantee depends on the features of the GMWB contract. The GMWB can be terminated at any time without additional cost.
Some plans have offered another approach in their plan design. When a participant retires, the plan can make the 5% payments from the participants’ account.
For some plans that don’t permit periodic distributions, a participant can roll their account over into an individual variable retirement annuity and the high water amount (typically called the benefit base) would carry over from the plan, so that the participant could continue to have the full benefit of the GMWB.
Another approach is to accumulate interests in annuities along the way. These interests are similar to guaranteed investment contracts (GICs) with a stable principal value and interest accruals. They may be included in asset allocation models as an allocation to fixed income. At retirement, the interests are convertible into annuities at the participant’s election.
A third approach, which can be either inside or outside of a plan, is an annuity platform, which offers several insurance companies and guaranteed products as distribution alternatives. Participants could opt to use an individual retirement annuity for part or all their distributions.
Delivery of Retirement Income Products
Retirement income products need to be coordinated with the recordkeeper’s services to be made available through the recordkeeper’s platform. Plan fiduciaries would need to decide whether to add one or more of the guaranteed income options on the recordkeeper’s platform to their plan line-ups. Once these options are added, participants would decide whether to add a guaranteed option to their accounts. Plan sponsors may decide to select a target date fund that includes a guaranteed income feature to the plan. As a QDIA, participants would be defaulted to that investment. A guaranteed income product available as the plan’s only distribution option would also need to be coordinated with the recordkeeper’s services.