ERISA Advisory Council Makes Case for Annuities as Part of QDIA

Experts at an ERISA Advisory Council hearing recommended that annuities should be part of a defined contribution plan’s default investments as a hedge against longevity risk.

The council is a 15-member body that gives advice to the Department of Labor as needed. On Monday, the first of a three-day meeting, the council explored the possibility of making lifetime income options more prevalent as qualified default investment alternatives. In May, the council decided to host the meeting to further research QDIAs in DC plans and health insurance appeals processes. The council is chaired by Mayoung Nham, a principal at Slevin & Hart PC.

Olivia Mitchell, a professor of insurance risk management and the executive director of the Pension Research Council at the Wharton School of the University of Pennsylvania, testified in favor of a specific default annuity structure in DC plans. She recommended that participants be defaulted into a product in which approximately 10% of their plan balance at age 65 is used to purchase a deferred annuity that does not begin to pay until they are about 80 or 85 years of age.

Mitchell argued that a “default annuity, not for your entire nest egg, just 10% of your money,” balances several concerns. Since it would not begin to pay until the participant is older, it is more targeted to addressing longevity risk—the risk of outliving all savings. It would also address the fact that “financial decisionmaking and financial literacy often decline later in life,” because participants would need to do less to manage decumulation of their plan assets as they get older.

She acknowledged to the council that this is a one-size-fits-all approach, but she said defaults should be simpler and will often take that form. A more tailored approach would be more expensive and complicated, and “employers might not have the time and money to do that much analysis,” but “if people want extra bells and whistles, that can be offered as well.”

Michael Finke, a professor of wealth management at the American College of Financial Services, spoke more generally to the benefits of annuities as default options in DC plans. He explained that DC plans are very good at accumulating assets, but “not very good at getting the money out,” meaning it can be difficult for participants to budget from a pot of money. An annuity, however, provides them with regular income that is more easily budgeted.

When retirees have a reliable income for life, Finke said that research shows they tend to spend more because there is “less need to be cautious,” since they cannot run out of savings. This effect can be dramatic, because retirees spend income more liberally than they spend savings.

Adding to Mitchell’s point, Finke noted cognitive decline in old age, which can further aggravate the difficulty of budgeting from a pile of assets as opposed to monthly checks.

Lastly, Finke acknowledged that annuities can be complicated, and “people don’t really understand what they are.” He briefly recommended that the council explore additional disclosures that could help explain annuities to participants using them and added that putting the contracts in plans could protect participants from buying lower-quality annuities in retail markets out of ignorance, since plan fiduciaries are better situated to choose safer products.

Federal legislation pending since June 2023, the Lifetime Income for Employees Act, would make it easier to use annuities as a default option as long as no more than 50% of participant contributions were invested into one. Annuities are not banned, per se, as defaults, but DOL regulations require QDIAs to be available for withdrawal every three months, a requirement that most annuities cannot satisfy. The bill would remove this requirement for annuities, provided they comply with the 50% limit.

The council will host additional experts on Tuesday and Wednesday to further discuss QDIAs and health insurance appeals.