For defined-contribution-plan participants who worry about running out of cash in retirement, annuities such as guaranteed minimum withdrawal benefits could be the answer. The catch: In exchange for lifetime income, retirees lose control of their money for decades and must brace for relatively low returns.
But Prudential Retirement, a division of Newark, New Jersey–based Prudential Financial, learned that annuities have plenty of fans after surveying participants in its plans with a guaranteed retirement income option. Of the more than 2,300 respondents, those who had chosen such in-plan programs said they were highly satisfied, citing “upside market potential, retirement income protection during down markets, flexibility, and lifetime guaranteed income,” according to a 2012 Prudential report. The authors also point to a 2011 poll of plan participants by consulting firm Towers Watson in which more than half of respondents said they’d pay higher fees for guaranteed retirement income.
But less than 10 percent of U.S. defined contribution plans offer in-plan annuities, according to the Washington-based Employee Benefit Research Institute. Plan sponsors are reluctant to meet demand, partly because doing so could expose them to risks they hoped to escape by abandoning defined benefit schemes. One of the biggest: If an annuity fails to pay a claim, participants could sue their employer for failing to live up to its fiduciary responsibility.
Under the Department of Labor’s so-called safe harbor provision that covers selecting annuities for individual account plans, sponsors must meet fiduciary duties that include assessing the provider’s ability to make all future payments and judging whether fees, commissions and other costs are reasonable. Even the annuities that Prudential Retirement offers to the defined contribution plans it administers rely on plan sponsors as fiduciaries.
The DoL guidelines seem intended only to cover a sponsor that selects an out-of-plan annuity for participants or gives them a range of choices; once a selection is made, the plan transfers the employee’s assets to the annuity. An in-plan annuity that may have to pay out benefits for 30 or 40 years is a different matter.
“Unfortunately, many plan sponsors, although interested in offering lifetime income solutions, are unwilling to take on this responsibility without an explicit safe harbor [rule] outlining how it should be fulfilled,” says Jeff Eng, director of retirement income solutions at Seattle-based asset manager Russell Investments. Eng says his conversations with providers have convinced him that the DoL expects the sponsor to conduct its own due diligence or hire an expert. “If the DoL were to provide an explicit safe harbor, I would expect to see an increase in adoption of these solutions,” he adds. (The DoL had no comment on whether it will revise its guidelines.)
Aon Hewitt will offer guidance to fiduciaries that make the ultimate decision on annuities, says Steve Shepherd, a Norwalk, Connecticut–based partner with the consulting firm’s Hewitt Ennis-Knupp division, which helps plan sponsors with de-risking and asset distribution. Defined contribution sponsors have gone from requesting information about annuities to seeking aid in offering them, Shepherd notes. He suggests that sponsors treat an in-plan annuity like any other asset by asking their investment adviser to take on the job of fiduciary.
However, three of the biggest investment advisers — Fidelity Investments, Pacific Investment Management Co. and T. Rowe Price — don’t offer that service for in-plan annuities, even though they administer trillions of dollars for defined contribution plans. The same goes for the Big Four accounting firms: Deloitte Touche Tohmatsu, Ernst & Young, KPMG and PricewaterhouseCoopers.
Several advisers to defined-contribution-plan sponsors said they counsel those clients on helping participants to find out-of-plan annuities. But sponsors should be careful, says Leon LaBrecque, founder and chief strategist of LJPR, a Troy, Michigan–based wealth management firm that has advised Ford Motor Co. and General Motors Co. on moving from defined benefit to defined contribution plans. “As soon as you offer an annuity product, you become the fiduciary on that product,” he warns.
Participants stand to get a better deal by purchasing an annuity through a large employer. But for the sponsor, LaBrecque thinks the cost of defending a choice of annuity in court could outweigh the benefit to employees — “especially when you consider the reason plan sponsors went from defined benefit to defined contribution strategies to begin with was to de-risk.” • •
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