How Retirement Funding Will Get A Little Easier

You should soon have the option of funding an annuity within a 401(k)s. This is owing to bipartisan legislation that appears to be a slam-dunk for passage. The measure also allows people to wait longer until they have to tap their retirement savings. But how will these provisions work out? For answers, we turn to Lewis Walker, a financial planning and investment strategist at Capital Insight Group in Peachtree Corners, Ga.

Larry Light: This is one of the rare instances where both parties and the president apparently agree on an issue.

Lewis Walker: The House of Representatives overwhelmingly passed the Secure Act, which stands for Setting Every Community Up for Retirement Enhancement, by 417 to 3. The bill, containing changes for 401(k)s and traditional IRAs, endorsed by AARP, is expected to pass in the Senate. Like all legislation, the devil will be in the details.

New is the introduction of annuities as a 401(k) option, the ability to convert some or all of your savings to lifetime guaranteed income. Since guarantees are made by the issuing insurance carrier, there will be intense focus on the financial health and claims paying ability of the carrier.

Light: The mandatory feature that eases the mandatory withdrawal mandate is welcome, too.

Walker: You bet. Currently, when you reach age 70½ you must begin withdrawing money, called a required minimum distribution, or RMD, from qualified retirement plans every year. The amount is based on federal life expectancy tables. And you have to do it,  even if you don’t want or need the money. The new age to start RMDs will be 72. This does not apply to a Roth IRA, which has no RMD requirement.

Light: When people inherit an IRA, even if they are nowhere near retirement age, they need to start taking withdrawals for the rest of their lives. How has that changed?

Walker: After this year, if you inherit a traditional tax-advantaged IRA, and you’re other than a spouse or minor child, you lose the lifetime stretch-out. You would have to withdraw the money within 10 years of the owner’s death, paying ordinary income taxes at your marginal tax rate.

There are benefits for longtime employees who work part time, at least 500 hours a year. That could help those wishing to ease into retirement, while employers could profit from legacy knowledge.

Light: How does the annuities part work?

Walker: Long sought by the life insurance industry, the big change will be inclusion of annuities as investment options. Currently, if you leave an employer and roll your 401(k) into an IRA, you can buy an annuity inside of your IRA. However, Congress wants to make it easier for you to accumulate savings in an annuity in your 401(k), money that can be converted into predictable lifetime income as found in traditional pension plans, the likes of which are fast disappearing.

Light: Is this a good idea?

Walker: Applied to you as a unique individual, the answer must be, “It depends.” As an advisor who understands annuities and has been critical of some sales practices, I find that more questions arise than do answers. We’ll have to see what products are approved and then fully vet and understand contract details as they apply to a person’s overall situation. Annuity contracts are highly complex documents, not easily understood by many.

Light: From what we know now, what can we expect?

Walker: How does a pension plan type annuity work? Suppose you’re a life insurance company and I offer to invest a certain amount of money in return for you guaranteeing me at some point a fixed monthly payment for life, or for a certain period. The first question you ask is my age.

An annuity is the opposite of life insurance. A life insurance actuary knows that of 10,000 men or women of the same age in a given health classification, a certain number will die each year. They just don’t know specifically who will die, but they know what their claims liability is likely to be.

With an annuity, the reverse holds true. With an annuity beneficiary pool, they look at how many are likely to live and for how long? In deciding what to pay monthly, the company makes assumptions about interest rates, investment returns, etc., while creating a buffer to return a profit.

Light: The insurer is making a bet on your lifespan, it seems. And so are you, as the annuity holder.

Walker: With an annuitized single life payment, as the annuitant, I am betting I will outlive the average, recoup my investment and then some. Once I die, payments stop and there’s nothing left for heirs. The minute I hedge my bet, covering a spouse, for example, the payments decrease because there are two lives in the longevity equation. Payments decrease if a “period certain” is introduced, for example, you pay me or my beneficiary for at least 10 years or so, to guarantee a given return if I “die too soon.”

Light: What about costs?

Walker: If the insurance company is guaranteeing income in a low interest rate environment, payments will be lower. You, the annuitant, assume the inflation risk since there are no cost-of-living adjustments, or COLA, on payments. How much of your nest egg will be devoted to guaranteed income versus growth? How much liquidity can you give up in exchange for a fixed lifetime income stream? How much of the income stream can be transferred to a surviving spouse?

We’ll have to wait and see what comes to the marketplace. Determining what may be right for you will require in-depth analysis of your overall net worth, all sources of retirement cash flow, and a myriad of other questions. The devil will be in the details and your particulars.