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A Very Simple Policy Improvement: Allow QLACs in DB Plans

In its 2017 Employee Benefit Survey, the Bureau of Labor Statistics found that 36% of workers in traditional defined benefit plans had an option at normal retirement to take a lump sum benefit, as did 90% of workers in non-traditional DB plans (cash balance and pension equity plans). To understand the significance of the latter figure, consider that more than one-third of defined benefit plans are “non-traditional.”

Just as in defined contribution plans, DB plan participants like lump sums. And, while an exclusive focus on a participant’s need for retirement income has led some to criticize the availability of DB lump sums, there are post-retirement risks for which a lump sum may be more appropriate—for instance, unanticipated major expenses.

Indeed, many argue, with respect to DC benefits, that, rather than a life annuity, the ideal distribution form is a lump sum plus a deferred annuity that begins making payments at, e.g., age 85. Under this approach, the participant can manage her retirement assets/income/consumption against a fixed longevity risk horizon, to age 85. Then, if she lives that long, the annuity clicks in, providing payments during her “super-longevity.”

The Regulatory Issue and the QLAC Solution

Deferred annuities were, however, understood to present a problem under the tax code’s required minimum distribution (RMD) rules, which generally require that distributions under a tax-qualified retirement plan (e.g., defined contribution plans, defined benefit plans and IRAs) be paid over the employee’s life or life expectancy, beginning no later than the required beginning date, currently the April 1 following the individuals 72nd birthday.

In 2014, in an effort to encourage the use of annuities in defined contribution plans, IRS amended its regulations on the RMD rules to allow DC plans to make available to a participant a “qualifying longevity annuity contract” (QLAC), a deferred annuity from an insurer beginning no later than age 85, so long as the premium paid for the contract did not exceed the lesser of $125,000 (indexed, currently $135,000) or 25% of the participant’s account balance when the annuity is purchased. 

QLACs are viewed very favorably by Congress, and, indeed, there are bipartisan proposals in both the Senate (Portman-Cardin) and the House (SECURE 2.0) to liberalize current QLAC rules by eliminating the 25%-of-the-account-balance limit.

QLACs Only for DC Plans?

When the QLAC initiative was begun (way back in 2014) there was something that made no sense to me: payment of QLACs, that is, deferred, “longevity” annuities, were only allowed for DC plans—even though, as noted above, lump sums are a significant (and popular) benefit form in DB plans generally and cash balance plans in particular. Don’t participants electing DB lump sums face the same issues that participants in DC plans face—the risk of outliving the drawdown of their lump sum distribution?

As I understand it, the perception of policymakers was that there was no need for “DB QLACs.” Perhaps that is because DC QLACs are a provider-based solution, and there are a number of annuity carriers that were interested in developing that business. As a result, unlike DC plan participants, DB plan participants could not defer the commencement of any portion of their benefits beyond the required beginning date—the April 1 following age 70½ in 2014 (and now age 72).

Maybe DB QLACs Would Be an Upgrade…

It’s my understanding that, notwithstanding its popularity with policymakers and insurers, there is still not a lot of QLAC uptake in DC plans. Getting DC participants to buy annuities, generally, has been a problem. We’ve just seen a spate of providers/provider coalitions begin to offer, e.g., regular (non-QLAC) annuity products in default target date funds—presumably as a way to overcome this annuity hesitancy on the part of DC participants by avoiding the need to persuade them affirmatively.

Is it possible that QLACs might work better in DB plans? To state some obvious features of this approach: DB plans (traditional and non-traditional) already offer annuities (as the default), paid from the plan. DB annuities, for a variety of reasons, are understood to be more efficient—and thus a better value—than insurance company annuities. Many view the ERISA protections provided with respect to them (including PBGC insurance and ERISA fiduciary rules) as superior. And many argue that participants trust their employer and employer-provided benefits more than an outside provider.

But even if none of that were true, why not allow QLACs in DB plans? If QLACs are good for DC plans, why shouldn’t they be allowed, more or less on the same terms, in DB plans—even though there is no big industry lobbying heavily for their availability.

At a time when everyone is struggling to push annuities into DC plans (which many of us believe is a difficult fit at best), why can’t we make this benefit innovation—the deferral of annuity commencement to advanced ages—available in plans that already pay annuities as a matter of course and in which the participant interest is likely to be greater?

Michael P. Barry is a senior consultant at October Three and President of O3 Plan Advisory Services LLC, which provides retirement plan regulatory analysis targeted at plan sponsors and those who provide services to them.

Opinions expressed are those of the author, and do not necessarily reflect the views of ASPPA or its members.