The SECURE 2.0 Act of 2022 (SECURE 2.0) significantly changes the legal and administrative compliance landscape for U.S. retirement plans. Foley & Lardner LLP is authoring a series of articles that take a “deep dive” into key SECURE 2.0 provisions that will affect how employers structure and administer their 401(k) plans, pension plans, and other types of employer-sponsored retirement plans.
Recent contract negotiations in the auto industry included a demand from organized labor for the reinstatement of traditional retirement plans that include lifetime payment options. While the tentative contract agreements do not include traditional pension plans, the subject of retirement income that a participant cannot outlive remains a top priority for both organized labor and for the retirement community more generally. An increasing number of employers (while firmly embracing a defined contribution retirement structure) are exploring whether to offer annuity payment options within their defined contribution plans. Further, recent studies have concluded that plan participants would be interested in defined contribution plan distribution options that permit the participant to elect an annuity distribution option with respect to a portion of the participant’s defined contribution balance. In response, Congress has made incremental changes to encourage (although not require) annuity options within defined contribution plans.
The original Setting Every Community Up for Retirement Enhancement (SECURE 1.0) Act was enacted in December 2019 and generally became effective on January 1, 2020. SECURE 1.0 included a requirement that defined contribution plans provide participants with an estimate of the lifetime annuity that could be purchased with the participant’s account balance. SECURE 1.0 did not require that defined contribution plans provide an annuity payment option, although the law brought attention to lifetime annuity payment forms through the required disclosure of an estimated annuity amount. SECURE 1.0 also added a fiduciary safe harbor for reviewing an insurance carrier’s financial stability in connection with the selection of annuity contract vendors under the plan.
Similarly, SECURE 2.0 did not mandate that defined contribution plans include a lifetime annuity distribution option, but the law nevertheless included incremental enhancements to three annuity distribution rules that might make defined contribution annuity distribution more attractive.
Calculation of Annual Required Minimum Distribution Amount Where a Portion of the Account is Used to Purchase an Annuity
Plan participants generally must receive minimum annual payments from their retirement plans (and individual retirement accounts) for each year beginning with the year in which the participant reaches his or her required beginning date (currently age 73 and ultimately increasing to age 75).
When a defined contribution account is used to purchase an annuity, the periodic annuity payment generally exceeds the minimum distribution amount that would have been required on that portion of the account if the amount used for the annuity purchase had instead remained in the plan. The rules in effect prior to SECURE 2.0 essentially required that the required minimum distribution for the portion of the account that is not used to purchase an annuity be determined without regard to the portion of the account that was used to purchase an annuity or the payments that the participant receives under the annuity contract. SECURE 2.0 amended this rule (and directed the Department of Treasury to change its regulations) so that a participant has the option to calculate the required minimum distribution amount based on the total account value with a credit for the amount of payments received during the year under the annuity contract.
Certain Increasing Annuities are Now Permitted
The required minimum distribution rules generally require that annuity payments be non-increasing. SECURE 2.0 allows payments under a defined contribution plan annuity contract to increase at a constant percentage prescribed under the contract (not to exceed five percent annually). This potentially makes lifetime annuity contracts an attractive distribution option by providing the participant with a degree of inflation protection.
Qualified Longevity Annuity Contracts
A Qualified Longevity Annuity Contract is a deferred annuity contract that is purchased within a defined contribution plan account and that provides for payments commencing at a pre-determined date (not later than the participant’s attainment of age 85). The Qualified Longevity Annuity Contract seeks to address the longevity risk inherent in a defined contribution plan — the risk that the participant will out-live his or her money — by reserving a portion of the participant’s defined contribution balance for a lifetime annuity, the payment of which commences at a deferred, but preestablished, date.
Previously, the maximum amount that could be invested in a Qualified Longevity Annuity Contract was the lesser of 25% of the defined contribution account value or $125,000. SECURE 2.0 eliminated the 25% of account value restriction and increased the dollar cap from $125,000 to $200,000. The $200,000 maximum threshold is also indexed for inflation.
The portion of a defined contribution account invested in a Qualified Longevity Annuity Contract is not taken into account when determining minimum required distributions for years prior to the date on which payments under the Qualified Longevity Annuity Contract begin.