IRS, EBSA Give Boost to TDF/Deferred Annuity Combinations
Plans interested in providing lifetime income alternatives via target-date funds that include deferred annuities just got some much-needed clarity from the IRS.
In Notice 2014-66, the IRS provides a special rule that enables qualified defined contribution plans to provide lifetime income by offering, as investment options, a series of TDFs that include deferred annuities among their assets — even if some of the TDFs within the series are available only to older participants.
Coincident with the publication of the IRS Notice, Assistant Secretary of Labor Phyllis Borzi, in a letter to Mark Iwry, Senior Advisor to the Secretary and Deputy Assistant Secretary for Retirement and Health Policy at the Treasury Department, confirmed that the use of unallocated deferred annuity contracts as fixed income investments, as described in the IRS Notice, “would not cause the Funds to fail to meet the requirements of paragraph (e)(4)(i) of the QDIA regulation,” as long as the designated investment manager satisfies each of the conditions of the annuity selection safe harbor. The letter affirms that the plan sponsor, as the appointing fiduciary, must “prudently select the investment manager and monitor the selection at reasonable intervals, in such manner as may be reasonably expected to ensure that the investment manager's performance has been in compliance with the terms of the Plan and statutory standards, and satisfies the needs of the Plan.”
What Borzi’s letter also makes clear is that the fiduciary of the plan is not responsible for selecting the annuity provider, so that the annuity purchase safe harbor rules have no application. The current annuity purchase safe harbor rules are often cited as an impediment to plans offering annuities because many see them as providing little protection to fiduciaries. (The DOL has an item revising the annuity purchase safe harbor regulations on their guidance plan for January 2015.)
The IRS notice explains that this special rule provides that, if certain conditions (specified in the Notice) are satisfied, a series of TDFs in a DC plan is treated as a single right or feature for purposes of the nondiscrimination requirements of Code Section 401(a)(4). According to the IRS, this permits the TDFs to satisfy those nondiscrimination requirements as they apply to rights or features even if one or more of the TDFs considered on its own would not satisfy those requirements.
In the Notice, the IRS explains that if the deferred annuity within a TDF is made available only to older participants (say, with a target date designed for those in that age cohort), these participants could disproportionately consist of highly compensated employees (because, as a group, older employees are often higher paid than younger employees). In that case, the IRS notes that making TDFs with deferred annuities available only to older participants presents the question of whether the use of age-restricted TDFs could violate the current availability or effective availability requirement for benefits, rights, and features under Treas. Reg §1.401(a)(4)-4. The Notice was developed in response to requests for guidance that the use of a series of TDFs to provide lifetime income in this manner does not violate those nondiscrimination requirements of Section 401(a)(4).
The notice also provides examples of specific TDF series that would be eligible for relief. It will be published in Internal Revenue Bulletin 2014-46 on Nov. 10, 2014.