Clearing Underbrush for ALDAs May Not Be Enough                  

The biggest challenge facing participants in 401(k) plans will be figuring out how to draw down their balances in retirement.  Retirees have to decide how much to take out each year.  If they take out too much, they risk running out of money; if they take out too little, they risk not covering basic needs.

These risks could be eliminated through the purchase of annuities, but people have little interest in traditional annuities.  They are expensive for the average person because they are priced for people who will have long lives (the typical purchaser) and they require lots of marketing costs.  But even more fundamental is that people do not want to hand their wealth over to anyone.  They like holding a pile of assets and, moreover, they may need that pile if they get sick. 

The Advanced Life Deferred Annuity (ALDA) seems like an annuity that people might actually buy.  Essentially people would purchase a product at 65 that would begin making payments at 85.  This means that people could have “longevity insurance” at a fraction of the price required for an annuity product that starts payments immediately.  It also defines the period (65 to 85) over which people can spend their resources, which makes drawing down accumulated assets much easier.  

Despite the ALDA’s strengths, it is still a strange product that will take consumers some time to understand.  Providers of this product are hardly being overrun with customers. 

Moreover, regulatory barriers and sponsor concerns have impeded the offering and adoption of ALDAs.  In February of this year, the Treasury proposed removing some of the constraints. 

First, the proposed regulations would make it easier for sponsors of defined benefit plans, 401(k) and other defined contribution plans, and IRAs to offer participants more options.  Participants would no longer face an “all or nothing” choice, but could split their assets – purchasing an annuity with part and taking the rest as a lump sum.   

Second, the proposals would make it easier to offer an ALDA by relaxing the Required Minimum Distribution (RMD) rules.  RMD rules require that plan assets be distributed over the life expectancy of the participant after the participant reaches age 70 ½.  These rules were designed to ensure that retirement plans are used for retirement security rather than to avoid estate taxes on bequests to heirs.  However, the regulations also impede the offering of ALDAs.  The proposed regulations would exclude amounts invested in ALDAs (up to a specified limit) from the calculation of the required minimum distribution.  For example, if an individual had an account balance of $100,000 and invested $15,000 in an ALDA, only $85,000 would be subject to the minimum distribution rules. 

Third, the proposals would clarify 401(k) spousal benefit rules for ALDAs and other options where lifetime income begins in the future.  The retirement plan rules require that participants who select certain distribution options obtain notarized consent from their spouse.  But it was unclear when that requirement applies.  Under the proposals, spousal consent would not be required before the annuity begins, and once it begins the insurance company issuing the annuity would be responsible for compliance with the spousal consent rules.    

These changes help make it easier to offer annuities and particularly facilitate the provision of ALDAs.  But people are never going to buy these products without prodding.  My choice would be to have an ALDA as the default for a portion of distributions from 401(k) plans.  A default is the only way that people will end up with protection against outliving their resources.