New Rules Favor Annuities for Retirement

The White House last week strongly endorsed annuities as a needed but missing piece of Americans’ retirement plans. New rules just might set in motion some interesting retirement plan changes.

Among financial products, annuities have long been a very hard sell.  This is due to nothing short of the general public misunderstanding the annuity product.  Investors often opt for glamorous opportunities such as Facebook’s IPO and fail to comprehend annuities and their benefits.  In my practice, enlightening clients on the value of annuities has become a priority, having even developed a free website devoted entirely to annuity education.

The premise of an annuity is simple: Give some money to an insurance company and they will make guaranteed payments to you for the rest of your life. The money can be paid now or in the future. The payments can begin whenever you want and by using it to supplement benefits such as Social Security, the common fear of “outliving your money” can be calmed.

Insurers have muddied the water somewhat by loading down basic annuities with multiple features, fees, and product types.   This unfortunate circumstance may cause people to shy away from annuities, but it shouldn’t, as the basic premise still remains the same.  Annuities behave like defined-benefit pension plans. Once they’re in place, they produce regular payments for recipients.

The set of rules announced recently will support retirement-plan annuities in four ways:

1. They will permit splitting retirement distributions into lump-sum rollovers and annuities. Many employees don’t think about more flexible choices when cashing out of workplace plans. The new rules encourage so-called “split options” and simplify the process.

2. They encourage the use of “longevity annuities.” This is the name given to an annuity that doesn’t begin making payouts until the person typically celebrates their 85th birthday. Because the payments are so far in the future, the current price of such annuities is relatively low. Longevity annuities are considered a particularly good tool for women, who outlive men and typically need more lifetime income protection. The new government rules would encourage longevity annuities by extending the required minimum distribution rules (RMDs) for retirement accounts. RMDs must now be taken from 401(k)s and IRAs when the account holder turns 70½.

3. For employers who have both defined-benefit pensions and defined-contribution 401(k) plans, the new rules would allow employees to use some of their 401(k) assets to buy low-cost annuities in their employer’s defined-benefit plan.

4. Current spousal consent rules can block plans from offering longevity annuities and other deferred annuities where income payments begin at a future date. The new rules protect spousal rights to benefits but defer the required consent until the annuity payments actually begin.

Some of last week’s changes are already in effect. Others should be implemented before the end of 2012.  These are executive orders and do not require congressional approval.

Even with new rules, changing retirement-plan offerings and investor behavior could take years. For example, a set of important 401(k) changes contained in the 2006 pension-reform legislation took several years to take hold. But, it has led to huge gains in retirement plan participation.  I expect the same positive outcome to occur with annuities.

As always, my recommendation for any individual (working or retired) is that they consult with an experienced financial advisor to assure their assets are being properly managed and protected.  This is especially true for those approaching retirement age as a significant loss in portfolio value could be catastrophic.  There are plenty of safe opportunities that allow for growth and protection of assets and understanding your options is a mandatory first step.

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