Private Sector Solutions for Legal and Regulatory Barriers to Annuities in 401(k) Plans

By David Pratt

Research Overview

The most important legal and regulatory barriers to annuities in 401(k) plans arise under the Employee Retirement Income Security Act (ERISA), enacted on September 2, 1974, and rulings thereunder by the U.S. Department of Labor (DOL) and the Internal Revenue Service (IRS). In this regard, the most important single section of ERISA is § 404(a), which requires fiduciaries of an employee benefit plan to discharge their duties with respect to the plan solely in the interest of the plan participants and beneficiaries. Section 404(a)(1)(A) states that the fiduciary must act for the exclusive purpose of providing benefits to the participants and beneficiaries and defraying reasonable plan administration expenses. Section 404(a)(1)(B) requires a fiduciary to act with the care, skill, prudence, and diligence under the prevailing circumstances that a prudent person acting in a like capacity, and familiar with such matters, would use. Over the past 30 years, the number of traditional (defined-benefit) pension plans in the private sector has declined dramatically, and the dominant form of retirement plan is now the 401(k) plan. The focus of concern has recently shifted from accumulating 401(k) plan assets to providing greater retirement income security for 401(k) plan participants and beneficiaries. In 2010 the DOL and the U.S. Department of the Treasury (the Treasury) solicited information on how they might enhance retirement security by facilitating access to, and use of, lifetime income or other arrangements designed to provide a lifetime stream of income after retirement (the request for information). The request for information generated considerable public comment but there were few actual developments. Part of the delay may be attributed to a certain ambivalence on the part of the DOL. On the one hand, the DOL wanted to encourage lifetime income; on the other hand, it was wary of relaxing the strict fiduciary standards of ERISA. The Setting Every Community for Retirement Enhancement (SECURE) Act, enacted in December 2019, includes major lifetime income–related provisions that will reduce some of the barriers that have discouraged the use of lifetime income products by defined-contribution plans, and hopefully will also encourage participants to think about their retirement savings as being capable of producing a lifetime income stream. The U.S. retirement system is huge. According to the Federal Reserve Board, total financial assets of pension funds were $23.4 trillion as of March 31, 2020, of which $7.5 trillion was attributable to defined-contribution plans, including 401(k) plans but excluding individual retirement accounts (IRAs), which hold more assets than 401(k) plans. Given the uncertain state of the economy as a result of the business disruption caused by the coronavirus, and the difficulty of enacting bipartisan solutions, it will be difficult for the federal government to enact significant legislation or issue major regulatory guidance. Accordingly, this is a good time for the Alliance for Lifetime Income, other industry groups, and groups advocating for the U.S. retirement system (such as the ERISA Industry Committee, the American Benefits Council, and the American Retirement Association) to think creatively about how to develop and implement private sector solutions to improve retirement income security. This paper considers some of the possible industry solutions and discusses changes that can be accomplished only by means of legislation or regulatory guidance. Increasing the use of lifetime income solutions in 401(k) plans is not a short-term endeavor. Extensive targeted education of plan sponsors, investment advisors, recordkeepers, and individual plan participants will be essential. Product development and redesign to meet the needs of plan sponsors and plan participants will be important. Individuals’ aversion to annuities, though often irrational, is deep seated, partly because they have been encouraged to focus on the accumulation of assets as an end in itself, rather than as a means of providing retirement income. Hopefully, the insurance industry will be willing to invest the necessary resources, to change long-established marketing and distribution practices, and to allow time for the initiatives to bear fruit.

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About the Author

David Pratt is the Jay and Ruth Caplan Distinguished Professor of Law at Albany Law School. He received his law degree from Oxford. Since 1976, he has specialized in retirement plans and other employee benefit programs. He is the author of the Social Security and Medicare Answer Book and coauthor of Pension and Employee Benefits Law, ERISA and Employee Benefit Law: The Essentials and Taxation of Distributions from Qualified Plans. He has also written numerous articles and is a frequent lecturer. He is the Chair of the Life Insurance and Employee Benefits Committee of the Trusts and Estates Law Section of the New York State Bar Association and a fellow of the American College of Employee Benefits Counsel.

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