Using a Fixed Index Annuity in a 401(k) Plan
There has been a tremendous amount of debate among regulators and in the financial industry concerning the merits of using annuities as investments in 401(k) plans. Given the longer life expectancies of most Americans today, the market turmoil during the last decade and the aging population (most who cannot afford another market downturn) annuities with guaranteed income benefits are a valuable addition to one’s retirement portfolio. However, there are some that still question the merits of placing an annuity in a qualified plan such as a 401(k) plan. The opponents will argue that it does not make sense to place a product that offers tax deferral features into another tax-deferred vehicle. This argument falls short however, as the primary reason for using the annuity within the 401(k) plan is to take advantage of the guarantees the annuity offers. Keep in mind, it is always recommended that an analysis of the fees charged by any provider be thoroughly reviewed by the qualified plan sponsor so as not to breach their fiduciary duties. A more in-depth discussion of plan fees is available in a written report from K-Plan Retirement Advisors.
The Revenue Act of 1978 included a provision that became Internal Revenue Code (IRC) Sec. 401(k) (for which the plans are named), under which employees are not taxed on the portion of income they elect to defer into the plan rather MARKETSthan receive as cash payments. The Revenue Act of 1978 added permanent provisions to the IRC, sanctioning the use of salary reductions as a source of plan contributions. The law went into effect on January 1, 1980. Regulations were issued in November of 1981. Since that time assets in 401(k) plans have increased exponentially. Total assets in 401(k) plans reached a record $3.075 trillion in 2010, according to the 2011 Marketplace Update from the Society of Professional Asset-Mangers and Record Keepers (SPARK) and The SPARK Institute. The report noted that there were 536,000 401(k) plans, covering more than 74 million workers in the U.S. in 2010. Additional statistical highlights of the report include:
• 401(k) participants had nearly 70 percent of their account balances in stocks at the end of 2010, including the equity portion of balanced, life cycle, risk-based allocation and target date funds.
• An estimated 20-22,000 new 401(k) plans will be formed in 2011, primarily by small companies.
Given the data above, plan administrators have a significant opportunity to offer an investment to 401(k) participants that may have one or more of the following characteristics or features:
• Lets participants benefit when the market is heading up
• Protects their account balance and credited gains so they are never subject to a market loss
• Provides guaranteed lifetime income
This product, called a Fixed Index Annuity, can help 401(k) plan participants’ address both accumulating retirement savings and receiving income in the form of lifetime withdrawals. The specific features depend both on the specific product and on the riders purchased with the contract. In general the annuity must be able to have deposits credited to the account in the same manner in which elective deferrals are made from the plan participant’s salary. Therefore, single premium annuities are not suitable for 401(k) plans. Annuities that are offered as an investment option should have a published interest rate crediting history of at least 10 years for comparative proposes.
It is important to work closely with the 401(k) Plan Administrator to ensure that the Plan will allow participants to invest in a Fixed Index Annuity as part of their 401(k) account balance. Working with the 401(k) Plan Administrator is of upmost importance to make sure the plan stays in compliance with the rigorous rules that they must follow. These rules may include fiduciary responsibility under ERISA to select and monitor the fixed index annuity contract issuer, spousal notice and consent rules for plans that make lifetime payment distributions, portability and rollover rules, required minimum distribution rules, and others.
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