One of the hardest things retirees face is turning savings into income during their retirement. Many investors, and even financial planners, struggle with this challenge. To that end, annuities have been touted by a number of pundits and politicians as a way to solve the issue. The two SECURE Acts helped on this front, but more help is needed.
And investors may just get that lifeline.
The reintroduced Lifetime Income for Employees Act, or LIFE Act, could go a long way in making sure annuities can be included in 401(k) and other workplace retirement plans. But offering these assets in places where most Americans have their savings could do wonders for retirement income security.
Tackling the Hard Part
When it comes to saving for retirement, the actual savings is the easy piece. Socking money away and letting it compound for decades can be a chore, but it’s a pretty simple exercise. The hard part is turning that savings into a steady stream of income. It’s here that many investors and even their advisors struggle to find a foothold.
There are numerous ways to think about that income – dividends, bond interest, steady withdrawal rates like the 4% rule, bucket strategies, etc. However, none provide potential stability to that income and expose retirees to various market and other risks during a time of relative vulnerability.
To that end, annuities have been touted as a way to solve the retirement income crisis and reduce the strain on investors. Both SECURE Acts had provisions allowing for annuities to be included in various workplace and individual retirement plans. However, more work is needed.
It’s here that an effort of rare bipartisanship was formed. Representatives Donald Norcross, D-New Jersey, and Tim Walberg, R-Michigan, have re-introduced the Lifetime Income for Employees Act, or LIFE Act. 1
The LIFE Act In a Nutshell
This is actually the third time – first in 2020 and again in 2022 – Norcross and Walberg have introduced the legislation. Essentially, the LIFE Act would allow annuities to be included as a default investment option by modifying the Employee Retirement Income Security Act of 1974. By tweaking that bill, certain kinds of annuities would be allowed to be considered “qualified defined investment alternatives”, or QDIAs, for workplace retirement plans.
When a worker is enrolled into a 401(k) or similar plan, there’s a default fund option that their assets are placed in. It used to be simply cash or a money market fund. However, changes to legislation in 2006 and plan rules have allowed for other options. These days, it’s almost always a target-date fund.
And that’s not a bad choice for investors just starting out or for those who have no idea about asset allocation. However, a target-date fund doesn’t solve the income equation in retirement. The reintroduced LIFE Act will allow plan sponsors to make an annuity the default option.
To make sure it complies with 2006’s QDIA rules, investors must have a mix of asset classes as the default. With the LIFE Act, no more than 50% of investment contributions can be allocated to the annuity fixed income component. The rest would be bread & butter stocks and bonds through a mix of mutual funds, collective trusts and other pooled investment vehicles just like today. So, you could find that the default in the LIFE Act period is half in a target-date fund with the other half being in the annuity.
In addition, the LIFE Act leans on the fiduciary obligation of the plan administrator to make prudent selections/defaults based on age and other tolerance factors. Here, a younger investor may only have 5% of their contributions defaulted into an annuity, while workers only a few years from retirement may be at the full 50%.
The updates to the bill include several opt-out provisions. Plan participants have up to six months to opt out of the annuity choices, and they must explain their other alternatives in plain English. During those 180 days, withdrawals from the annuity come without fees, penalties or any other charges. However, after the 180 days have expired, the plan can gate investors’ money and even charge surrender penalties if an employee chooses to withdraw from annuity investments. The idea is to lock in the long-term income potential and keep employees engaged and the annuities in order to help generate that stream of income later in life.
Plenty of Pros & Cons
Ultimately, the LIFE Act could be seen as providing a real benefit for investors. By making annuities a potential default option for portfolios, it helps create individual pension plans for investors to solve the income equation.
The bill does have some issues, however.
Portability and rollover questions are raised from the bill as there is no mention of what happens to the annuities if a person transfers jobs or rolls over their money to an IRA. 2
Secondly, annuities are very steady, but they don’t necessarily provide strong returns. Investors may actually lose out on more income by selecting the annuity than investing it, then buying an annuity later on. Both SECURE Acts provide plenty of ability for investors to purchase annuities with qualified funds in retirement plans. It may be better to invest the funds normally and buy an annuity at or near retirement.
Secondly, fees come into question. Fiduciary rules have pushed many plans into very low cost funds. By and large, annuities are more expensive than a mutual fund. The guarantees aren’t free. This could create a sour taste in many investors’ mouths and plan sponsors are most likely not going to foot the bill for any surges in costs related to the LIFE Act.
The Bottom Line
Finding income in retirement is a major problem for many investors. Annuities have been tapped as a way to solve this equation, with the reintroduced LIFE Act allowing them to be the default option in workplace plans. For investors, it’s good news with a side of caution.
1 Congress.gov (July 2023). H. R. 3942
2 Rep Norcross (July 2023). Rep. Norcross Reintroduces Legislation to Improve Retirement Security for American Workers