The coronavirus pandemic has upended daily life across the country, and Americans remain focused on safety for themselves, their families and their retirement plans. In fact, new data from New York Life and Morning Consult found 57% of Americans say physical health takes increasing priority. Fifty-three percent of respondents say they are increasing their prioritization of their finances and 28% say retirement is taking increasing priority.
For many seeking safety in this environment, financial products like annuities can become more attractive. The same New York Life study found that among people who are likely to seek financial advice, 62% say they are more interested in a product with a predetermined payout that does not change, regardless of how the market is doing, and 56% say they are more interested in a product that allows them to benefit from stock market growth, while also providing a floor for how much they could lose.
Income for life?
Although these stats suggest positive momentum for guaranteed income, a small but significant tax provision in the SECURE Act is cause for concern. This provision removes the lifetime stretch for many beneficiaries of inherited individual retirement accounts and requires that accounts be distributed within 10 years after the year of the death of the owner. The issue? Many qualified income annuities being sold today are presented as allowing payments longer than 10 years after the death of the owner. If those annuities were purchased inside an IRA, extending payments beyond 10 years may no longer be possible.
Drafters of the bill were somewhat aware of this potential issue and built a provision into the bill that grandfathers certain existing annuities under the old lifetime stretch provisions as long as they were qualified income annuity products sold before Dec. 20, 2019 (prior to enactment of the SECURE Act) in which the income annuity payments were fixed and irrevocable. Certain other products were then subject to the 10-year term. While I use Dec. 20, 2019, there are some uncertainties around the right dates here, especially with some potential look-back and free look provisions at the state level.
In other words, if you bought an income annuity prior to Dec. 20 in an IRA, that qualified income annuity is exempt from the 10-year period if it was irrevocable in the manner that the annuity would pay out. It also appears that a joint-and-survivor annuity for life to the beneficiary as the beneficiary of the IRA would have been exempt. It also means that if these types of qualified income annuity products were sold on or after Dec. 20, 2019, they are not exempt.
Here are two simple examples where this issue might arise:
- A financial professional sells a qualified income annuity to a married couple in 2020 in the husband’s IRA. The annuity is a deferred income annuity that will pay income for life for the husband and then continue payments for life to the surviving spouse as beneficiary of the IRA. However, the wife is 15 years younger than the husband. A few years later, they divorce, and the IRA and beneficiary are never changed. The surviving ex-spouse now has no exception to the 10-year distribution rule but the annuity promised to pay for life.
- A father bought an annuity in his IRA that pays out for life and then 20 years. However, the beneficiary is a non-minor child of the IRA owner. The initially expected 20-year period won’t adhere to the new 10-year stretch. Or simpler, a joint lifetime annuity with a non-minor child of the IRA owner as the beneficiary.
Impact on financial professionals
At the same time that financial professionals continue to promote the value of guaranteed lifetime income, they also continue to highlight lifetime payments for annuity owners and beneficiaries. We know that for certain products, this won’t be the case – putting financial professionals in a difficult position.
Here’s why: Most contracts of this nature have commutation or endorsement clauses or language about legal changes that occur that give the insurance company the right to modify the contract to adhere to current law. Income annuities sold after 2019 could be modified to adhere to current law, and commutation clauses could be used to fix contracts that do not adhere to the 10-year rule. Insurance companies may look to do a present-value analysis and calculation of the benefit and offer it as a lump sum or in a 10-year payment to comply with current law. There were modifications occurring before the SECURE Act to help annuity distributions comply with applicable beneficiary rules.
Insurance companies are afforded the flexibility within annuity contracts to make these adjustments, but the beneficiary might not receive the same benefit that was promised originally by the agent who placed the contract – putting financial professionals in the position of promising a benefit that the consumer may not ultimately receive and the consumer purchasing a product they do not fully understand. Today, professionals across the industry are not being equally equipped with the right tools to express the details of how these policies might play out with the SECURE Act changes in place.
What can be done
In the immediate term, insurance companies and IRI members should work together to get the right education and information into the hands of their agents and the end consumers to inform them that not all contracts will pay out to beneficiaries for longer than 10 years.
Here are some questions that financial professionals can ask:
- Was the income annuity contract sold on or after Dec. 21, 2019?
- Is the annuity a qualified annuity in an IRA or qualified plan?
- Is the beneficiary an eligible designated beneficiary?
- Is the joint annuitant a non-spouse?
- Does the contract pay for life to a beneficiary?
- Does the contract pay for a term longer than 10 years to the beneficiary?
- Is the beneficiary more than 10 years younger than the owner?
Is there a real issue here? Well, I spoke to Gary Mettler, an annuity expert, and he is very concerned about the complexity of the issues. Mettler wants to see insurance carriers get ahead of this issue as soon as possible to explain how they plan to modify the contracts to comply with the SECURE Act.
In May, he ran a Cannex report in which all 20 carriers quoted in the report were showing a quote for selling qualified joint-and-survivor single premium immediate annuities with a 100% joint survivor option where the age difference is 15 years. This is a clear situation in which if a divorce occurred before the death of the owner, there could be a SECURE Act issue with the 10-year payout and the upfront expectation to get income for life to the survivor. This is something that could easily become an issue in the future if sold today. As Mettler pointed out, it’s not clear all of the carriers would issue the contracts, but the quotes are showing up in Cannex for all of them.
So where do carriers sit today? Dylan Huang, senior vice president and head of retail annuities at New York Life, said many of the large insurers were well-aware of this issue and preparing for it, including New York Life. “In order to ensure financial professionals and consumers understand how the provisions in the SECURE Act might impact their retirement plans, we began offering resources on the SECURE Act and its implications – including on the 10-year stretch provision and the impact on non-eligible designated beneficiaries – to our agents and third-party advisor partners early this year,” Huang said. “We have also included a summary of SECURE Act policy impacts in all of our annuity policy delivery kits since January.”
Guaranteed income has always been an important component of Americans’ retirement planning, but it becomes even more critical in the current environment when other sources of retirement income are under stress. Financial professionals play a key role in helping retirees ensure guaranteed income is part of their plans and we must continue to set them up for success. However, the lack of certainty around how these contracts will be modified puts fiduciaries and insurance agents in a tough spot with clients, as their messaging might not align with what the carrier eventually does with the contract in order to comply with the new provisions of the SECURE Act.
Jamie Hopkins is director of retirement research for and managing director of Carson Coaching.