While the pandemic and its economic repercussions have (rightly) dominated the news for nearly two years, they have obscured some dramatic and longer-lasting changes that have been rolled out for 401(k) investors.
The Setting Every Community Up for Retirement Enhancement Act, better known as the Secure Act, became law on Dec. 20, 2019, just before the pandemic took hold. That, plus further regulatory tweaks by the Biden administration in 2021, have led to three major additions to retirement plans and one loss for some investors.
“I’ve never seen more change in the 401(k) space in my career as I have in the past 18 months,” says Matt Wolniewicz, a 30-year veteran of the retirement-plan industry. Wolniewicz is now the president of a new financial-services consortium called Income America. These recent changes have dramatically altered the landscape for investors planning for retirement.
This time, good news comes in threes: Investors interested in sustainable funds will soon find more options in their plans; those looking for guaranteed income in retirement will have an annuity option; and people working at smaller companies that don’t offer retirement plans may soon find themselves with a 401(k). Investors who took advantage of an unusual provision that allowed them to put more money into a Roth IRA may find that loophole closed soon.
Here’s what you need to know.
Annuities have long had a bad reputation for being overly complex, pricey, and sold by hucksters rather than integrated into a comprehensive financial plan. But the guaranteed income for life that they provide is, for many people, crucial to a long and happy retirement.
“I’ve never seen more change in the 401(k) space in my career as I have in the past 18 months.”
— Matt Wolniewicz
Yet most retirement plans haven’t offered an annuity option. While they’re not explicitly disallowed, the bar was high to justify including them in a plan. The Secure Act reduced the liability for plans to offer annuities, providing what is known as “safe harbor,” which protects plan sponsors legally if an annuity issuer goes bust. (Sponsors still must do an appropriate amount of due diligence as fiduciaries when selecting these products for their plans.) The rationale: 401(k) plan participants should have the benefit of guaranteed lifetime income, similar to what employees enjoy in traditional pension or defined-benefit plans.
Annuity options are being paired with target-date funds, which were probably the last big change to 401(k) plans when they were introduced in the 1990s and allowed to become the default option (for investors who don’t choose other investments) in employer plans in 2006. These asset-allocation funds shift their weightings toward more-conservative investments as the target date for retirement (say, 2030 or 2040) approaches. But these funds aren’t typically designed to get someone all the way through retirement. For that, you need steady income—and sometimes guaranteed income in the form of an annuity.
Wolniewicz’s firm, Income America, is a consortium that launched in March 2021 with the goal of selling annuities linked to target-date funds in retirement plans. It is backed by several investment and insurance heavyweights, such as American Century Investments, Lincoln Financial Group (ticker: LNC), and Nationwide.
Income America’s new addition is its 5ForLife group annuity contract. Once a plan participant in a target-date fund turns 65, the amount in the fund can be converted into the annuity, which pays 5% of the total amount at age 65 for the rest of the participant’s life. The account stays invested in the target-date fund after 65, and the recipient keeps any gains above the age 65 amount, while losses don’t affect the 5%-a-year payout. Participants aren’t locked into the annuity, either, and can withdraw their assets at any time. Income America already has seven retirement plans signed up for 5Forlife, and the annuity became available in the plans this January.
Other firms are offering similar products, yet the formula for how guaranteed income for life is paid varies significantly from provider to provider. In November, State Street Global Advisors launched an annuity product called IncomeWise as part of its target-date-fund lineup. (State Street selected insurance provider MetLife as the annuity provider inside IncomeWise.) For now, the IncomeWise feature is offered only in the University of California’s retirement plan, which has $35 billion in assets and 300,000 participants. IncomeWise is a deferred-income annuity—also called a qualified longevity annuity contract, or QLAC—that begins paying income when participants turn 80. In return for waiting until 80, investors can put less money down for a higher income stream than so-called immediate annuities, which start paying income at retirement.
“Relative to an immediate annuity, you get roughly three times the buying power [for the deferred annuity],” says David Ireland, State Street’s head of global defined contribution.
Plan participants can invest up to 25% of their assets or $135,000, whichever is less. Regulators currently limit the amount you can invest in QLACs, as they are exempt from retirement plans’ taxable minimum-distribution rules in retirement.
According to Ireland, someone retiring today could invest $100,000 and collect $1,000 to $1,400 a month once they hit age 80, depending on the annuity’s features. If an investor dies before age 80, the entire investment is returned to their heirs. Otherwise, the initial investment is locked up.
Contrarily, BlackRock LifePath Paycheck can act like an immediate annuity that makes payouts as soon as you retire. The annuity contract portions of the Paycheck target-date products are issued by insurers Equitable and Brighthouse Financial (BHF). You can increase the payout if you choose to delay receiving any income—a feature designed to resemble Social Security, which pays more if you wait. The annuity offers a “joint life option” that, if selected, covers both you and your spouse for lifetime income. It also offers the option of a guaranteed 10-year payout, and if you die beforehand, pays the remaining income of the period to your heirs. “One of the behavioral reasons why people don’t want to select an annuity is they feel that ‘if I give you this money and I pass away in a year’s time, then I’ve lost the money,’ ” says Nick Nefouse, BlackRock’s head of Retirement Solutions. “The way we’ve structured this is your dependents will continue to receive the money to take that [anxiety] off the table.”
So far, five plan sponsors with about 100,000 participants, including the Tennessee Valley Authority and Advance Auto Parts (AAP) , have signed up for LifePath, Nefouse says.
Pooled Employer Plans
While the announcements from annuity providers have been primarily for big retirement plans, small ones will soon start seeing annuities, too. In fact, more small retirement plans in general are going to exist. That’s because the Secure Act created a new kind of retirement plan called the Pooled Employer Plan, or PEP. PEPs are centrally administered 401(k)s that can be joined by multiple unrelated employers, allowing businesses to outsource plan management.
Employees at big firms are far more likely to have a 401(k) plan, according to research firm Cerulli Associates: Almost 90% of private-sector companies with at least 500 employees offer a workplace retirement plan, whereas only about half of employers with fewer than 50 employees offer them. PEPs are meant to close the “coverage gap” for small businesses. When surveying executives of small companies that didn’t offer 401(k)s, Cerulli found that 39% said they didn’t because plans were too expensive, and 34% because they were too busy running their company to manage one. Outsourcing is simpler and cheaper, as the combined scale of a PEP reduces costs. In fact, about a quarter of surveyed companies with under $1 billion in assets in existing 401(k)s were also interested in joining PEPs when they become available.
In October, Lincoln Financial announced that it was launching a pooled employer plan called OpenPEP, in collaboration with plan fiduciary and administrator National Professional Planning Group and financial-research firm Morningstar (MORN). “When we’re looking at cost savings and the efficiencies that are coming about through joining these [PEPs], we’ve seen as much as a 40% cost reduction,” says Michael Salerno, CEO of NPPG. Salerno says four plans signed up for OpenPEP within a month of its launch, and that NPPG and Lincoln are already working on about 100 plan conversion/addition proposals for 2022.
To differentiate OpenPEP from competitors, plans will also offer Lincoln PathBuilder Income, an annuity target-date investment similar to Income America’s 5ForLIfe, which Lincoln Financial also helped design.
While annuities and PEPs are the 2019 Secure Act’s progeny, the Department of Labor made a significant change to plans in October 2021 with a ruling that encourages plan sponsors to employ environmental, social, and governance, or ESG, criteria to select plan investment options.
Now that it has passed what’s called the public “comment period,” the DOL’s rule is expected to be finalized by the middle of this year. Though some plans already have ESG options, the rule also applies to a plan’s default investment option, or Qualified Default Investment Alternative (QDIA), which is what employees are enrolled in automatically when they join the plan. That’s typically a target-date fund, and most employees end up keeping their assets in it. According to analysis by fund giant Vanguard of its retirement-plan assets in 2020, 60% of participants held a single-fund option in their account, and 91% of them were invested in a single target-date fund.
Previously, plan sponsors were hesitant to include ESG funds because of a Donald Trump–era rule exposing them to legal liability for pursuing “nonpecuniary objectives.” Although not finalized, the new rule’s language states very clearly that “climate risk is investment risk” and that ESG factors affecting returns should be considered when selecting fund options.
The demand for ESG is clearly there. According to BlackRock’s 2021 survey of plan participants, 73% say it’s important to have ESG options; 49% of millennials say it’s very important. “Participants want this,” says Anne Ackerley, head of BlackRock’s retirement group. “It’s very much on plan sponsors’ minds.” But because including a default option that participants don’t select themselves adds to legal liability, plan sponsors may remain hesitant. “I don’t think [the ESG shift] happens quickly, but it will happen over time,” says Ackerley.
Given the convergence of these changes, it is even likely that default target-date funds will eventually have both ESG and annuity features.
While plan investors are gaining new options, they may be losing one, too. In its current form, the Biden administration’s Build Back Better bill would eliminate what are known as backdoor Roth IRA conversions from 401(k)s and traditional IRAs. But there is no guarantee that the current version of the bill will pass, as there is a lot of infighting within the Democratic Party over it.
Normally, taxpayers with incomes exceeding $140,000 can’t contribute to Roth IRAs, which allow tax-free withdrawals in retirement. But they can contribute on an after-tax basis to traditional IRAs and then convert those into a Roth IRA—hence the back door. They can also roll over a highly valued 401(k) into an IRA and then convert that into a Roth.
Starting in 2032, Build Back Better would eliminate such conversions for single taxpayers earning in excess of $400,000 a year or married couples earning more than $450,000. It also would bar any after-tax contributions in IRAs or 401(k)s from being converted to Roths starting in 2022. The current limit on pretax contributions, i.e., tax-deductible contributions, is an annual $6,000 per individual investor for those under age 50, or $7,000 if you’re over 50. This would kill backdoor Roth conversions for the wealthiest investors.
Yet another bill, introduced in May of 2021 and dubbed the Secure Act 2.0, seems likely to pass, as it has bipartisan support, and it gives investors more opportunities to expand their wealth. It would gradually increase the age when 401(k) and IRA investors must take a taxable required minimum distribution from 72 to 75, allowing their assets to grow tax-free for longer. The rule also increases the maximum amount of pretax contributions for those ages 62 to 64—what is known as the “catch-up limit”—from $6,500 a year to $10,000.
It seems that with so many changes afoot, the government giveth and the government taketh away—but then, if you wait a little bit, it giveth again.