The Markets February 26, 2021

Why Annuities Are So Helpful in Today’s Market Environment

Thanks to increases in longevity and lower expected returns from stocks and bonds in the foreseeable future, annuities are now seen as a big part of the solution.

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“It is a real challenge for retirees today that people are living longer, with retirements now lasting 20 to 30 years and interest rates being so low,” said Jonathan Barth, registered investment adviser (RIA) consultant with DPL Financial Partners, speaking during a webinar the company sponsored, titled, “Practical Market Assumptions for Today’s Retirement Realities: Why Adhering to Traditional Income Strategies No Longer Works.”

“Some bonds are returning as little as 1%, and some are even negative,” Barth said. “This is making advisers look at different solutions to secure retirement income.”

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Michael Finke, a professor of wealth management at The American College, said that, historically, bonds have returned 5%. “Depending on their maturity, Treasurys are delivering about 1%, and corporate bonds, 1.5% to 2%,” he said, explaining that all-in it now costs about $150,000 to buy annual income of $1,000 from bonds. “Investing more heavily in equities seems to be the only answer, but they are becoming quite expensive. Valuations today are as high as they have ever been. This is depressing for new retirees.” Annuities, Finke added, can provide comparable income at a much lower cost

David Blanchett, head of retirement research, Morningstar, said it is imperative for advisers to lower return assumptions in their models. In the next 10 years, Morningstar forecasts that cash will return 0.6%, bonds 1.2%, equities 5.7%, international bonds 1.5% and international equities 6.3%, he said. Morningstar’s forecast beyond the next 10 years for bonds is 4.8%, for U.S. equities is 9.0%, for international bonds is 4.4% and for international equities is 7.6%, he added. “This is bad news for investors, but you have to give them a realistic assumption,” Blanchett said.

Barth said: “How are advisers adapting to low bond returns, high uncertainty, increasing life expectancy and fee compression? We surveyed 200 practices and found they are increasing risk in retirement plans, and are increasingly interested in annuities to deliver a secure retirement for their clients.”

The survey also revealed that 43% of advisers said their clients are delaying retirement, 59% said their clients are saving more, 46% are taking more risk in their portfolio and 50% are spending less, Barth noted.

Finke said it has become important for advisers to consider “the advantages of annuitization in a low interest rate environment. You just can’t get as much from your safe investments as you used to. You can get 40% more income in retirement through annuitization than through bonds, and you are free from the risk that you are going run out of money. This enables retirees to spend their money on things that can make them happy in retirement.”

DPL’s survey asked advisers how they are adjusting portfolios to address low yields for clients nearing retirement, Barth said. Nearly one-third (30%) said they are delaying the transition from equities to bonds, 18% are actually increasing equity allocations, 26% are increasing their clients’ savings—but only 7% are turning to annuities, he noted.

Finke said there is a “tremendous disconnect between academics and practitioners when it comes to annuities. We all know that annuities are the best tool to safely fund a retirement. Advisers must consider using this tool if they are to do their job properly.”

Barth said that even though so few advisers are currently using annuities, 68% said they would consider using them—and not just to produce income. They also like their principal protection, tax-efficient legacy planning and wealth accumulation properties, Barth said.

Finke said it is time for advisers to be honest about return projections and the value of annuities. “If you run your Monte Carlo with realistic expectations about asset returns, you are going to come up with very different conclusions about the safety of your investment portfolio,” he said. “I’m not being pessimistic. I’m just being realistic. All of a sudden, insurance products become more attractive.”

Compliance February 25, 2021

SECURE Act and CARES Act Still Demand Client Diligence

As an example, if a plan sponsor has not yet started tracking part-time employees to see whether they accumulate 500 hours of service in 2021, they should begin doing so immediately.

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During a recent dialogue with the editorial team at PLANADVISER/PLANSPONSOR, two expert attorneys offered helpful words of guidance to retirement plan sponsors and service provider fiduciaries when it comes to meeting the requirements and opportunities presented by two key pieces of legislation: the Setting Every Community Up for Retirement Enhancement (SECURE) Act and the Coronavirus Aid, Relief and Economic Security (CARES) Act.

The full recording of the hourlong discussion with Percy Lee, associate attorney at Ivins, Phillips & Barker; and Aliya Robinson, senior vice president of retirement and compensation policy at the ERISA Industry Committee (ERIC); is available here. Presented below are edited highlights from the discussion, focused on the critical topics of required minimum distributions (RMDs) and the tracking of different types of hardship withdrawals, particularly coronavirus-related distributions (CRDs). The speakers also addressed the importance of tracking part-time employees’ working hours during 2021, 2022 and 2023, given that these workers must become eligible for retirement plan participation after three years of service—assuming they reach 500 hours in each year.

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Percy Lee on Part-Timer Workers

Looking back to the SECURE Act may feel like a lifetime ago for many plan sponsors. It became law in late 2019, prior to any real discussion of the pandemic. Very importantly, it delayed the RMD age from 70.5 to age 72.

That was perhaps the most important plan-related change made under the SECURE Act. Other important changes included permitting penalty-free withdrawals for a birth or adoption, expanding eligibility for long-term, part-time employees in 401(k) plans, and changing the rules for providing lifetime income disclosures and portable lifetime income products. And, of course, the SECURE Act established a new marketplace of pooled employer plans (PEPs), along with making other changes to health and welfare plans. Plan sponsors should be paying attention to all of these things.

Practically speaking, for this audience, one takeaway is that they should immediately begin tracking part-time employees’ hours. The SECURE Act says that plans must allow long-term, part-time employees to participate after they have clocked three consecutive 12-month periods with 500 or more hours of service. For this purpose, hour counting started on January 1, 2021. The same date applies even for plans and employers operating on a non-calendar-year basis. This means that employees who work 500 hours per year in 2021 through 2023 will become newly eligible in 2024, and they must be allowed to participate.

Of note, employees who are required to be covered by SECURE Act’s expansion may receive, but are not required to receive, matching employer contributions. Furthermore, they can be excluded for nondiscrimination testing purposes. There are still some places where we hope to get clarifying guidance, but, for now, the bottom line for employers is to prepare for 2024 by starting in 2021 to track part-time employees’ hours.

Lee on RMD Confusion

Based on my practice, there is some serious RMD confusion out there right now, in part because of what the SECURE Act did versus what the CARES Act did. Simply put, the RMD date is the deadline when distributions have to begin, and so by deferring the RMD point from 70.5 to 72, the SECURE Act allowed participants to wait longer to start those distributions. However, we must keep in mind that individual plans are allowed to have earlier required distribution ages. In effect, they could ‘grandfather’ in the 70.5 RMD age if they so choose.

Another point of emphasis is that, even after the SECURE Act’s passage, RMDs that had already previously started at the required age of 70.5 cannot be stopped. Under the law before and under the law now, once RMDs commence from an account, they must continue. What has caused confusion is that the CARES Act provided for a pause in 2020 for RMDs that had already begun. To be clear, pausing RMDs and outright stopping RMDs are not the same thing.

The CARES Act also added to the confusion in that it included specific provisions that provided special retroactive rollover treatment for certain very specific RMDs that had been started in 2020 and which would have been treated as RMDs were it not for the CARES Act. It’s important to slow down and review all of these interconnected requirements.

Aliya Robinson on Hardship Distributions and Resubmissions

Whether we are talking about provisions in the SECURE Act or in the CARES Act that allow people to recontribute dollars, to either catch back up in terms of retirement readiness or to avoid taxation of hardship withdrawals, this is going to present a real logistical challenge to plan sponsors. Take, for example, the SECURE Act provision that allows people to withdraw funds penalty free in the case of a birth or adoption, while giving them the option to recontribute the funds later.

First of all, a record is required on the front end, when the money is exiting the plan. This initial record is easy enough to create, because the various pieces of guidance confirm that plan sponsors can generally rely on self-certification on the part of plan participants, unless they know for a fact that the participant is making false representations. However, that record has to be labeled accurately as being a withdrawal for a birth/adoption, versus, say, a normal plan loan or a coronavirus-related hardship distribution (CRD).

You have to put a system in place that can keep track of this over potentially a long time period, and then the bigger questions come up on the back end. If a person wants to recontribute a certain sum of money, how do you differentiate these dollars from other types of new contributions? Can the person contribute above the normal limits when part of their contribution is the repayment of such a distribution? Should it all go to the same account or must these dollars be segregated in terms of pre-tax or after-tax dollars? What if the money came from an after-tax fund in the first place? All of these questions and the related tax ramifications are complex. 

It’s going to be much easier to manage the expanded loans permitted by CARES, because that recordkeeping infrastructure is already in place. The CRDs, on the other hand, are a whole new distribution. It’s not a hardship withdrawal and it’s not a plan loan, so you need to set up different systems to make sure you can track it.

Robinson on CRDs and Retirement Security

Right now, we are past the time where you can take CRDs, but we have to ask about the process of paying them back. These distributions may be recontributed, but they aren’t required to be. In effect, the plan sponsors will have to be tracking all of this over the next three years and then declare at some point whether money that exited their plan did so in the form of a taxable distribution.

Stepping back, I think the bigger question and concern is the potential impact on retirement security. Are people going to pay back these distributions? It’s not clear. What we are hearing from plan sponsors is that they want to push plan participants to repay this money, but they don’t know how much they can actually make this push. At what point do they go beyond providing education and step beyond their role?

And what happens if you move from one employer to another employer? Are you allowed to pay money from an old plan into a new employer’s plan? There are some big open questions here, and we are going to be watching out for further guidance.

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