Since President Bush signed the Pension Protection Act (PPA) into law in August, numerous pundits have predicted a bonanza for the mutual fund industry and a lost opportunity for the insurance industry. On the surface, it might appear that way, but a closer look reveals that the act actually creates significant opportunities for annuity advisors. Some of the provisions are effective immediately and others will go into effect during the next few years, but all of them will increase the opportunities for marketing annuities that can serve Americans’ retirement needs.
Section 829 of the PPA arguably provides one of the most significant and beneficial changes to existing pension law. Previously, nonspouse beneficiaries were not able to roll over any funds into an IRA from an eligible retirement plan. Depending on the specific provisions of the plan, when a plan participant died, the beneficiaries were typically limited in their distribution options; they could take their distribution over any period up to five years or take a lump-sum distribution. On Jan. 1, all of that changed, and a nonspouse beneficiary can now roll over her interest in the plan to her own inherited IRA and stretch the distributions over her life expectancy. The inherited IRA can be funded with myriad investments. A tax-deferred variable annuity, with its professional asset management, asset diversification and guaranteed death benefit, can be an attractive investment.
Beneficiaries must still take required minimum distributions from the account. However, by using the stretch capability, they can leverage tax-deferral options by drawing out their income-tax liability over a protracted period. For plan participants who are not married but have beneficiaries for whom they want to provide, the new tax law offers a way to leave assets to their survivors in a tax-efficient manner.
Another important provision of the PPA pertains to the use of annuities within qualified plans. Under current law, if a defined-contribution plan allows participants to select an annuity option, that selection is deemed a fiduciary decision and subjects the plan fiduciary to meet the “safest available annuity” standard under the Department of Labor Interpretive Bulletin 95-1. At a minimum, the standard requires that plan fiduciaries conduct an objective, thorough and analytical search to identify and select the “safest available” annuity providers.
Why would a plan fiduciary do this, particularly if he were faced with the possibility of a lawsuit from plan participants for not selecting the “safest available annuity”? The fiduciary can avoid this risk by simply removing an annuity option from the plan. The PPA eliminates the standard effective immediately and directs the secretary of the U. S. Department of Labor, within one year of enactment of the PPA, to issue regulations providing guidance on annuity selection. Getting rid of the standard opens up an area for annuity sales to providers, which was more limited. Providers can now have their products adopted by plan fiduciaries who can use the settlement options, such as annuitization or guaranteed living benefits.
LTCI and annuities
Another important element of the new law is that it addresses, as of Jan. 1, 2010, and effective for contracts issued after December 1996, the treatment of long-term care insurance riders that are added to annuities. Previously, the tax law addressed the treatment of riders used with life insurance only. The LTCI rider on a life insurance or annuity contract is generally treated as a separate contract from which distributions are generally tax-free. The new rules are inapplicable to contracts owned by qualified retirement plans. This change opens the door for advisors who want to attract clients needing LTCI but are concerned about whether an annuity or an LTCI contract can independently meet their financial needs during retirement.
Another important provision of the PPA pertains to the use of annuities within qualified plans.
But wait, there’s more. For example, the “last in first out” rule is thrown to the wind with Section 844 of the PPA because the cash surrender value of the annuity can be used to fund the LTCI portion of the contract without a tax consequence to the contract owner. Charges that normally would be assessed against the annuity’s cash value for such distributions are excluded from gross income. The charges will reduce the basis in the contract and will not be tax-deductible, but they may create an incentive for the annuity owner to use those assets when he needs them, rather than spending out of pocket for LTCI coverage he may never use. The contract owner can use the annuity’s cash to fund his retirement or long-term care needs, whichever he prefers. Ultimately, these new hybrid products are not seen as a replacement for LTCI coverage but as a form of self-insurance.
Section 1035 was also revised and expanded to allow for the tax-free exchange of certain insurance contracts. The section now provides that no gain or loss is recognized on the exchange of a life insurance contract, an endowment contract, an annuity contract for a qualified LTCI contract or the exchange of one qualified LTCI contract for another.
The PPA is an important act that reflects the concern shared by the president and members of Congress about the issue of inadequate retirement planning by the American public. This is especially true given that the average American has not saved enough and is not financially prepared for retirement.
Advisors would be wise to closely examine the PPA and communicate frequently and proactively with their clients on the implications of the new law. The result will be an improved relationship with their clients as they recognize the fact that their advisors are staying ahead of the game by monitoring the important legislative changes that can affect their retirement plans.
Peter A. Radloff, J.D., CRC, is vice president of the Retirement & Wealth Strategies Group for Jackson National Life Distributors LLC, the distribution arm of Jackson National Life Insurance Co. You can reach him at Peter.Radloff@jnli.com.